Because SMSF loans can be more difficult to service than regular loans, many people find that the purchasing power, that is, how much they can borrow to purchase property, of their SMSF is less than they might have hoped or expected. Today we look at a typical scenario where this occurs and what you can do to improve your SMSFs purchasing capacity.
Video on SMSFs purchasing capacity
Understanding the borrowing or purchasing capacity of your SMSF
Okay so one of the conversations we’re having really regularly with our clients is that they get very frustrated with the borrowing capacity or purchasing power of their Self Managed Super Fund. SMSF loans are difficult to service and we are very often finding ourselves being the bearer of bad news in terms of “this is how much you can spend with your Self Managed Super Fund” – and clients get frustrated. So we say, “let’s talk about it and try to see why this is like it is”.
What is purchasing capacity?
I’ve used an example here that is absolutely typical of what we would see — mum and dad have set up their SMSF and are looking to buy a property. They come to us to get the loan organised and here the conversation we have is that they want to spend $600k-800k , maybe more, and we have to go back and say actually even for a $500k property this is going to be very very tight and you probably can’t do it.
On the board behind me are the reasons why. So in this particular case we’re looking at a couple, so member one and member two. We are assuming that one member is earning $100k per annum and the second member is earning $50k per annum. We are assuming that the property is worth $500k and that the Super fund wants to borrow for $400k. If you look at the cashflow for the Self Managed Super Fund it actually makes sense that the bank wouldn’t be too happy to accommodate that request.
So on the one side we’ve got the money that’s going to come into the SMSF — that is the employer contributions for member number one and member number two, at the rate of 9.5% which is what the Government is requiring from the employer. We’ve got rental income of $20k — this will vary from property to property, but 4.5% rental return is not uncommon. That gives a total income of $33,750.
On the other side we have SMSF loan repayments (on a 30 year loan at 5.5% interest which would be pretty typical of an SMSF loan — that’s just over $27k of loan repayments a year. We’ve assumed that the administration of the SMSF (being the tax return, the audit, the company renewal etc) is going to cost $2.5k per year which is pretty realistic. And the costs associated with holding that property would be just 1% of the property value which is actually probably on the optimistic side.
So what we find is that the SMSF has had to spend $34,750 over the year. So we’ve got income which is less than the outgoings and that’s without any buffer, without anything going wrong, without even putting the bank’s goggles on to look at that loan application. So we’ve got a couple who combined are earning $150k and it’s actually not easy to service a loan for $400k. That is the reality of SMSF lending.
There are things that can be done to improve this situation. One is salary sacrifice for SMSF loans. If this couple in our example were in a position personally to give up some of their income and contribute it into their Super, that is going to increase the income of the Super — potentially quite substantially — and boost their borrowing capacity. The other thing is the rental income. If our couple wants to spend more, they may have to focus on properties that deliver higher rental income — whether they be commercial SMSF property or residential. These are the two main levers that can be used to actually increase the borrowing capacity of a self managed super fund. But it is difficult and it is due to the nature of a Self Managed Super Fund which has a limited amount of income.