Written by James Power, SMSF Specialist Advisor (SSA®)
Did you know there are many SMSFs with existing loans written several years ago? Take a dive into this Case Study to explore SMSF trustee Casey’s current loan situation.
Casey is a trustee of the Casey Super Fund. The Fund entered into a limited recourse borrowing arrangement (LBRA) 10 years ago, obtaining a loan through a Big 4 lender. This lender is no longer active in the market, meaning the Fund is now paying an interest rate of 10.19% pa. Casey decides to seek the advice of her Financial Planner, together with a Mortgage Broker, to see if she is able to restructure the loan in any way. The loan particulars are as follows:
Balance:
Interest Rate:
Repayment type:
Term remaining:
Monthly repayments:
$800,000
10.19% pa
Principal and interest
20 years
$7,821 pm
Can Casey refinance the SMSF limited recourse loan?
Refinancing a Limited Recourse Borrowing Arrangement (LRBA) entered into on or after 7 July 2010 is permitted subject to the LRBA meeting the requirements of s67A of SISA. This means the SMSF limited recourse loan can be refinanced (including any accrued interest on the borrowing) as long as it remains secured by the same asset – and no other asset.
Why would Casey want to refinance the SMSF limited recourse loan?
Lower interest rates
Many SMSF limited recourse loans were first set up when the Big 4 banks were offering them. At the time, the interest rates were significantly higher than loans outside of superannuation. Casey’s situation is similar to many other clients who still hold these legacy products, with residential interest rates over 10% pa with the Big 4. We are able to refinance these legacy loans to ones with rates as low as 6.79% pa (commercial rates as low as 7.19% pa), some with better features than the old legacy products. Paying a lower interest rate can help SMSF trustees use more of the funds income to diversify across other investments.
Superior features
Many older SMSF limited recourse loans were basic loan products with few features. There are products in the market today that offer redraw facilities, offset accounts, interest only options and the ability to make extra repayments. Care must be taken however with using some of these features. For example, use of a redraw facility effectively constitutes a new borrowing and is only permitted under SISA to undertake repairs or maintenance (but not to improve an asset).
Lower Loan to Value Ratio (LVR)
As many SMSF limited recourse loans were set up when the Big 4 banks first offered them, the properties themselves have had time to appreciate in value, while the loan balances have also typically decreased. Lenders usually price their loans relative to a property’s Loan to Value Ratio (LVR), so for these properties, there is a greater chance to refinance at a much lower rate.
Ability to reset the loan term
One of the disadvantages of owning property inside a SMSF is the inability to use the equity to purchase other investments, as you can do with property outside superannuation. This is due to the prohibition of creating a charge over fund assets pursuant to the SISA. If a fund trustee wishes to use more of the funds income to diversify across other investments, refinancing the loan back to a longer term may assist to achieve this, by reducing the monthly repayments.
Outcome – refinance $800,000 facility from inactive (Big 4 lender) to new non-bank lender
The Mortgage Broker advises that by changing to a new lender offering a far more competitive interest rate, with the option of extending the term back out to 30 years, the fund can reduce the minimum repayments required. The outcome of refinancing the loan is as follows:
Current loan
New loan
Balance:
Interest Rate:
Repayment type:
Term remaining:
Monthly repayments:
$800,000
10.19% pa
Principal and interest
20 years
$7,821 pm
$800,000
6.79% pa
Principal and interest
20 years (30 years)
$6,102 pm ($5,210 pm)
Offset facility
We are aware of some lenders in the market who offer offset accounts with the SMSF loans. However, this is a contentious area, as some of these lenders have structured their ‘offset accounts’ as ‘redraw offset accounts’, potentially creating a charge over the asset. It is therefore important to seek advice to ensure compliance with superannuation laws.
Conclusion
Despite the SIS legislation permitting refinancing to occur, many SMSF accountants, advisers and trustees we speak to are under the impression they are unable to refinance theirs or their client’s existing SMSF limited recourse loans. However, there are several non-bank lenders operating in this space offering products with lower interest rates and superior features, and it could save a lot of money.
There are still some SMSF limited recourse loan providers who charge significant percentage-based establishment fees, while other lenders have significantly lower fixed fees. Some lenders offer significant discounted fees for refinancing. As the re-financing must comply with the requirements of the SISA it is important to work through the costs and benefits with your Broker and Adviser.
James Power, Guest Contributor
Mortgage Broker, Mortgage Choice
BEc MCom MTaxFinPlan CA CFP®, Franchise Principal and MFAA Accredited Finance Broker, SSA®
With over 25 years’ collective experience across Financial Planning, Chartered Accounting, Banking and Self-Managed Superannuation, James understands how critical it is for his clients to get their loan structures right to build wealth for the future. He is one of the very few Mortgage Brokers in Australia who has earned the SMSF Association SMSF Specialist Advisor designation.
If you would like to get in contact with James Power, please visit his
SMSF Association ‘Find a Specialist’ page here.
If you have questions about your SMSF and wish to speak to an accredited SMSF Specialist in your area, e encourage you to use the SMSF Association’s ‘Find a Specialist‘ tool.
Disclaimer: The information contained in this document is provided for educational purposes only, is general in nature and is prepared without taking into account particular objective, financial circumstances, legal and tax issues and needs. The information provided in this article is not a substitute for legal, tax and financial product advice. Before making any decision based on this information, you should assess its relevance to your individual circumstances. While SMSF Association believes that the information provided in this article is accurate, no warranty is given as to its accuracy and persons who rely on this information do so at their own risk. The information provided in this bulletin is not considered financial product advice for the purposes of the Corporations Act 2001.