As you’re no doubt already aware, the Reserve Bank cut the cash rate another 0.25 percentage points to 3.85 per cent on Tuesday, the second cut this year, amid growing confidence that inflation is moderating.
When rates drop, borrowers not only celebrate at the prospect of lower mortgage repayments, many start thinking about borrowing more money. This begs the question, how much should a person borrow relative to their income?
Whilst the banks obviously have a views on this, bank regulator APRA identifies borrowers as risky if they have debts of six times or more than their incomes.
When interest rates were rock bottom, almost a quarter of home buyers were taking on debts of six times their incomes, peaking at 24.3 per cent of borrowers in December 2021, figures from APRA show.
That fell as low as 5 per cent in the June quarter of last year as interest rates rose, and edged up to 5.8 per cent by the end of last year. If another rate cut is forthcoming, we may see the percentage of borrowers pushing the envelope creeping up again.
In this week’s newsletter, we break down what an LRBA is, and how they provide a layer of protection to people borrowing money within their superannuation to invest in property.
A Limited Recourse Borrowing Arrangement (LRBA) is a specific type of loan structure that allows a Self-Managed Superannuation Fund (SMSF) to borrow money to purchase assets as a residential or commercial property within superannuation.
LRBA’s are structured in a way that limits the lender’s claim strictly to the asset purchased with the borrowed funds, rather than exposing the SMSF’s other assets, or the trustee’s personal assets, to risk in the event of a loan default.
Here’s how the protection works in more detail:
1. Limited Recourse Clause
At the heart of an LRBA is the “limited recourse” clause in the loan agreement. This clause ensures that if the SMSF defaults on the loan, the lender can only take possession of the specific asset that was acquired using the borrowed funds, typically a residential or commercial property held in a bare trust. They cannot pursue the SMSF’s other assets, such as shares, cash, or other properties, to recover the loan.
2. Separate Legal Ownership via a Bare Trust
The asset purchased under an LRBA must be held in a separate bare trust, with a corporate trustee often acting on behalf of the SMSF. This arrangement creates a clear legal separation between the borrowed asset and the rest of the SMSF’s assets. While the SMSF holds the beneficial interest in the property (meaning it receives rental income and bears any gain or loss), the legal title is held by the trustee of the bare trust until the loan is repaid in full.
3. Protection of Personal Assets
It’s important to note that trustees and members of the SMSF are not personally liable for the LRBA loan, provided the loan is properly structured and there are no personal guarantees. This is a key distinction from regular investment loans, where a lender might seek to recover unpaid debt from the borrower’s personal assets (like their family home or investments) if the loan goes bad.
What is a perceived problem with LRBA’s?
The problem that some people in government have with these loans is nothing to do with the loan terms or structure, it’s more to do with the fact the existence of these loans allows borrowing within a SMSF, which in turn contributes to more property being purchased, reducing supply and pushing property values even higher.
In Summary
The limited recourse feature acts as a protective barrier. It ensures that only the asset purchased through the LRBA is at risk, safeguarding the SMSF’s broader portfolio and shielding trustees’ personal wealth—provided all SMSF and legal compliance rules are met.
If you have clients who are considering investing in property within a SMSF, please have them contact us to discuss the loan options available to them.
Variable
The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR.
1 Year Fixed
The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR. At the end of the three year fixed period, the borrowers interest rate will revert to a standard variable rate for the life of the loan.
