Self-Managed Super Fund (SMSF) Loans are based on a combination of several related factors. Income, Super fund balance and applicable Loan to Valuation Ratios (LVR) all contribute to determine how much you can borrow. Your borrowing capacity will change as your circumstances change. Let’s look at each factor in turn.
Income is made up of Super Contributions and rent
As with any Mortgage based borrowing, loan amounts are based on the income you have available to meet the repayments. The more income you have the more debt you can cope with.
That’s called serviceability.
In the case of SMSF loans, serviceability revolves around the Contributions that have been made into the fund as well as the potential rent from the property you are buying. For PAYG employees those contributions comprise the Super Guaranteed amount paid by the employer to your nominated Fund. Evidence of the contribution is provided by showing pay slips and statements with an existing Industry Fund or in the case of an existing SMSF, Tax returns and Bank statements. If you are Self Employed, the contributions you make to your Super fund will be your income. It’s the contributions that act as your income for SMSF lending with the rent being assessed in the normal way. The maximum loan amount you can get, based on the rent and super contributions, is called your borrowing capacity.
The bottom line is you will probably have less borrowing capacity than you think.
Lenders are conservative with SMSF loans for a variety of reasons. They are cautious because of the need to protect a valuable asset like Super, especially when it’s held in such high esteem by the majority of Australians. Imagine the outcry if Super funds were impacted negatively due to a lack of care from the Lender. Also, they only have a small amount of data available on how this segment of the market will behave under duress because it’s so new. Clearly then, for a Lender, the simplest way to be safe is to be conservative when setting any Credit Guidelines. One of the easiest ways to control borrowing is to lower the LVR. By this I mean that when the LVR is set at say, 70%, the borrower needs to be able to contribute a larger portion of the purchase price than they would have to outside of Super.
As you may have guessed, LVRs are lower than those outside of Super.
This forces the borrower to put more money into the purchase and commits them to the transaction more effectively than a small contribution. It also eliminates anyone who doesn’t fit, hence no Mortgage Insurance required. More importantly for the Lender, a lower LVR removes significant risk of loss if anything goes wrong. Generally speaking, your borrowing capacity will determine the LVR with most properties falling between 60% and 70%.
Balance in your Fund
It might sound obvious but the reality of lower LVR’s mean you have to contribute more of your Super funds to the purchase. For example, a 60% LVR means you have to put in 40% plus the purchase costs such as S/Duty etc as your contribution. Of course you can accelerate the growth in your fund by making extra contributions though these amounts are limited by the Australian Taxation Office. An important factor to consider is where you are in your financial life and if tying up further capital into a preserved, non-accessible environment is right for you. Meaning that, contributing significant amounts to Super might make sense for someone nearing retirement while the opposite could be true for younger Australians. Regardless of your situation one thing holds true.
The larger the balance in your Super fund, the easier it will be to borrow. Generally, to avoid LVR tightening, finding a property solution in a sound area with good tenants would require a balance of approximately $200,000 as a rule of thumb.
The other issue to think about is that a Self-Managed Super Fund may not be the only option in your situation. A Super Fund has restricted access before retirement so it makes sense to discuss your particular position with a Financial Planner before committing to a SMSF.
Acquiring property through your SMSF is a decision that requires careful consideration and you have to ensure it supports your overall investment strategy AND avoids unnecessary risk. For more information download our SMSF Essentials Guide to Property Investing.