Self-Managed Super Funds (‘SMSF’) are a way of saving for retirement and can provide greater control of funds by individuals. This is because trustees decide on and implement the SMSF’s investment strategy and make all investment decisions.

SMSFs are generally prohibited from borrowing money. Changes to the Superannuation Industry (Supervision) Act 1993 (Cth) however have made it possible for a SMSF to borrow funds for the purpose of purchasing permitted assets, including residential property, under a Limited Recourse Borrowing Arrangement (‘LRBA’)[1].

The purpose of a LRBA is to better protect super funds should the borrower default in the payment of the loan as the lender’s recourse is limited to the particular asset that the loan relates[2]. This is achieved by having the property owned by a separate entity known as a custodian or bare trustee who holds the property as trustee for the SMSF trustee. If the borrower defaults in the payment of the mortgage, the borrower is liable to sell that particular asset held by the custodian trustee while the other assets in the SMSF are protected.

Process:

  • A propety is identified by looking at the potential rental income, current market value, potential capital gains and any compliance issues.
  • A custodian/bare trustee arrangement is set up. This entity will enter into the purchase Contract of Sale and hold the property until the loan is paid in full.
  • An application is made for the Limited Recourse Mortgage with the lender. If approved, the custodian trustee enters into a mortgage with the lender.
  • Following settlement of the property, the SMSF is entitled to income from the property (such as rent) from the custodian trustee, but it must also meet expenses related to the property including the mortgage repayments.
  • Once the loan has been repaid the title can be transferred from the custodian to the SMSF.[3]

It should be noted that most lenders will require a personal guarantee from the SMSF members in order to provide additional security for the mortgage. This means that, whilst the members will not need to make monthly mortgage repayments, if the mortgage defaults then the lender can look to the members to recover any loss should the sale of the asset not cover the loan.

It is important to seek financial and legal advice prior to setting up a SMSF or entering into a LRBA to understand the risks associated with these kinds of arrangements and the penalties for non-compliance.

[1] Section 67A Superannuation Industry (Supervision) Act 1993 (Cth)

[2] Section 67A(1)(d) Superannuation Industry (Supervision) Act 1993 (Cth)

[3] Image from http://www.batescosgrave.com.au/resources/super_necessities/limited_recourse_borrowing_arrangements_by_smsf