The benefits of Self Managed Super Funds are becoming widely understood, Property investors have been drawn to SMSF’s on the basis that you are now entitled to borrow to buy property. This is a great advance and has created a big opportunity for people to build their property portfolio. Ken Raiss from the accounting firm Chan & Naylor Accountants, outlines the top 10 rules that the ATO needs to consider to make SMSF’s even more useful.
Amid increasing pressure on trustees of self-managed super funds (SMSFs) to keep pace with the steady stream of quiet pronouncements from the ATO, we turn the spotlight on some overlooked SMSF guidelines in need of urgent reform in 2013.
As a relatively young but rapidly evolving model, SMSF compliance guidelines contain more than their fair share of unnecessary and arbitrary rules. Some of these are discriminatory, lack logic or simply make the process of providing for independent retirement unnecessarily difficult.
Chan & Naylor has compiled the following list of 10 SMSF rules that themselves either require retirement or modification.
The ATO must broaden the net of reform to ensure arbitrary SMSF ruling is afforded urgent review and the best interests of Australian investors are put first.
1) An SMSF must have no more than four members.
SMSFs are most often used to provide for retirement income for all family members, yet four trustee positions would not be enough to cater for the average Australian household. The figure should respond to the nation’s needs as opposed to forcing families to either leave family members out of the SMSF or pay to set up an additional fund.
2) An SMSF cannot borrow money to pay for improvements to a single acquirable asset.
Should a trustee require money to renovate a property, it cannot be loaned in an SMSF because it is considered to increase risk, though trustees are still allowed to borrow money to purchase that property or asset in an SMSF.
3) A person must pay to set up separate holding trusts per single acquirable asset with debt.
Instead of adding acquirable assets with debt into the same trust structure, trustees must pay to set up another.
4) Life insurance (which is tax-deductable in super) cannot be moved from an individual name to a self-managed superfund unless the existing policy is cancelled and reissued.
Those who experience a change in circumstances while doing so, such as entering a new age group or different health, could find their new policy does not provide the same cover as their previous insurance policy, or worse still, cannot be re-written.
5) If a person is insured in super, they can only claim tax deductions for TDP (total and permanent disability) provided they are unable to work in any occupation.
This should also apply for a person’s own occupation.
6) It is prohibited to buy residential property or unlisted shares through an SMSF from a related party (wife, family member, etc.), even if supported with a registered valuation.
It is, however, acceptable to do the same with commercial property or shares. As long as the sole purpose test is passed there should be no limitation on from whom the asset is purchased if executed at arm’s length.
7) After the age of 65, a trustee is no longer entitled to the three-year average contribution.
This is age discriminatory. Anybody should be able to benefit from the three-year average contribution entitlement regardless of age.
8) Once a trustee reaches the age of 75, he or she may no longer contribute the full super contribution limit of $25,000 per annum.
This rule is discriminatory, especially as more Australians are both living and working for longer.
9) SMSFs must pay for manual amendments with each change to the SIS Act.
However, the big superfunds, covered by their associations, adopt legislation changes automatically. An SMSF deed, through legislation, should automatically pick up any changes to the SIS Act.
10) Trustees can suffer destructive penalties of up to 93% on over-contributions.
Excessive penalties should be axed for genuine errors.
Why equity can help you buy again
Unlocking the equity in your home could help you purchase another. Chief executive of property advisory firm Property Mavens used her home’s equity to buy a Preston investment property. Picture: Lawrence Pinder
WE’VE all heard of the benefits of refinancing to get a better deal on your home loan, particularly a more competitive interest rate.
But what if refinancing could also help you buy an investment property?
“Borrowers may be able to refinance their existing home loan to access equity they may have built in their property, in order to buy an investment property,” Mortgage Choice chief executive Susan Mitchell said.
Refinancing with the aim of buying an investment property could allow borrowers to grow their wealth, according to Ms Mitchell, as, generally speaking, property was considered a safe asset class in Australia with decent returns over the long term.
“CoreLogic found that over the 10 years to June 2018, national dwelling values increased by over 40 per cent, a good return on investment,” she said.
But she cautioned there were a number of costs associated with refinancing, so it was important borrowers made an informed decision before jumping in.
The nuts and bolts
So, how does refinancing using equity work?
The Successful Investor managing director Michael Sloan explained that lenders would typically lend you 80 per cent of the market value of your home, less the debt you still owed against it.
“This is your usable equity as banks hold some back as security,” he said.
“So, say, for example, you have a $500,000 property and a $200,000 loan. Your usable equity will be $200,000,” he said.
As to what value investment property you could buy, Mr Sloan said a simple rule of thumb was to multiply your usable equity by four.
“But remember that one of the risks of property investing is spending too much,” he said.
“You need to buy well below the median house price ($742,000 in Melbourne, according to CoreLogic), in fact you shouldn’t be within $200,000 of it.”
Ms Mitchell said the figure depended on how much a lender determined a borrower could afford to repay.
“Available equity is important but the key factor a lender needs to consider is how much a borrower can afford,” she said.
“If a borrower does not have additional capacity to repay a proposed new loan, they may not be able to borrow, irrespective of how much equity they may hold,” she said.
Where do I sign?
And there’s the rub: having equity in your home is not a guarantee you’ll be able to access it.
“You can have a million dollars of equity but if you don’t satisfy the institution’s lending criteria, they are not going to loan you any money,” Mr Sloan said.
“The bottom line is they will take everything into consideration: for example, how many children you have, as the more you have the less you can borrow, your work situation and how much you spend on everything from your daily coffee to the tyres on your car.”
Lenders have also tightened their assessment procedures as a result of recent regulatory measures, such as The Australian Prudential Regulation Authority (APRA) imposing a 10 per cent benchmark in growth on investment lending last year.
This was introduced in a bid to curb activity in the housing market, Ms Mitchell said.
“These regulatory measures have resulted in lenders increasing their scrutiny of a borrower’s ability to service a loan,” she said.
“When deciding if an applicant can afford a mortgage, a lender will consider a borrower’s available ongoing income and from this allow for existing debt commitments and living expenses,” she said.
“Their decision will also factor in a buffer for potential increases in interest rates.”
But it’s not all doom and gloom. Ms Mitchell advised that borrowers could overcome the increased scrutiny by getting “financially fit”.
“Get out of debt, spend your money wisely and adopt a disciplined savings strategy to show lenders you can service a loan,” she said.
Air Mutual director Damien Lawler advised would-be investors to consult an independent broker who could access a range of lenders, which might have varying assessment procedures.
“Everyone is talking about the banks tightening up – which they are – but there are banks, particularly the smaller, tier-two banks, who are still lending,” he said.
And finally …
Mr Sloan said his No.1 piece of advice for would-be property investors was to play it safe and to have some funds in reserve if things go wrong.
“You should never buy (another) property if you have no extra money available to you after you settle, so you need to have a buffer. And protect what you are building with income protection and life insurance, if you have a partner,” he said.
New postcode restrictions for home loans
THE nation’s largest lender is tightening its belt and making it even tougher for potential borrowers to successfully get a loan.
In a notice issued to mortgage brokers today the CBA announced it will roll out a range of changes including restrictions on lending in some postcodes.
This includes forcing customers to stump up fatter deposits in order to get a home loan.
It will impact all types of properties including homes and apartments and also borrowers regardless of whether they are owner occupiers or investors.
In the notice it said from Monday, December 4 the key changes will include:
– Reducing the maximum loan-to-value ratio from 80 to 70 per cent for customers without Lenders Mortgage Insurance (an insurance the customer pays and protects the lender not the borrower.) This means borrowers with a deposit less than 30 per cent must pay expensive LMI costs.
– Reducing the amount of rental income and negative gearing eligible for servicing which will impact investors.
– Change eligibility for Lenders Mortgage Insurance waivers and LMI offers for customers in some postcodes.
CBA said the new Postcode Lookup tool which will start from Monday will allow the bank and brokers to determine whether a borrower can successfully borrow in a particularly region or postcode and it will reduce customers wasting time applying where they are likely to get knocked back on a loan.
CBA has not released the postcodes and regions these changes will impact.
The move is a result of the responsible lending restrictions put on lenders by regulators to cool the red-hot lending market.
Home Loan Experts’ managing director Otto Dargan said these changes are significant and will impact many borrowers.
“Lenders keep an eye on the economy and their exposure to different property markets and adjust their lending policies to manage their risks,” he said.
“We strongly recommend that home buyers don’t commit to buy a property until they have an unconditional approval from a bank.
“You could win an auction and then find out that your pre-approval is worthless, and then what are you going to do?”
Unconditional approval is when your loan application has been fully approved and is not subject to any terms or conditions.
Originally Published: brisbaneinvestor.com.au
One in five homeowners will struggle with rate rise of less than 0.5%
ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent.
Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.
But as we scramble over each other to snap up property while interest rates are at historic lows, we have gotten ourselves into a bit of a pickle. We might not actually be able to afford funding our affair.
An analysis, based on extensive surveys of 26,000 Australian households, compiled by Digital Finance Analytics, examined how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. And the results are distressing.
It showed that around 20 per cent — that’s one in five homeowners — would find themselves in mortgage difficulty if interest rates rose by 0.5 per cent or less. An additional 4 per cent would be troubled by a rise between 0.5 per cent and one per cent.
Almost half of homeowners (42 per cent) would find themselves under financial pressure if home loan interest rates were to increase from their average of 4.5 per cent today to the long term average of 7 per cent.
“This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards,” Digital Finance Analytics wrote.
The major banks have already started increasing their home loan rates this year, despite the market broadly expecting the Reserve Bank to keep the cash rate steady at 1.5 per cent this year.
Just this week NAB upped a number of its owner-occupied and investment fixed rate loans.
“There are a range of factors that influence the funding that NAB — and all Australian banks — source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said of the announcement.
“The cost of providing our fixed rate home loans has increased over recent months.”
So as interest rates rise and leave mortgage holders in its dust, it leaves a huge section of society, and our economy, exposed and at risk.
NOT TERRIBLY SURPRISING
Martin North, Principal of Digital Finance Analytics, said the results are concerning, albeit not surprising.
“If you look at what people have been doing, people have been buying into property because they really believe that it is the best investment. Property prices are rising and interest rates are very low, which means they are prepared to stretch as far as they can to get into the market,” Mr North told news.com.au.
But the widespread assumption that interest rates will remain at historic lows is a disaster waiting to happen, especially in an environment where wage growth is stagnant.
“If you go back to 2005, before the GFC, people got out of jail because their incomes grew a lot faster than house prices, and therefore mortgage costs. But the trouble is that this time around we are not seeing any evidence of real momentum in income growth,” Mr North said.
“My concern is a lot of households are quite close to the edge now — they are not going to get out of jail because their incomes are going to rise. We are in a situation where interest rates are likely to rise irrespective of what the RBA does … There has already been movement up.”
Australia’s wages grew at the slowest pace on record in the three months to September 2016, according to the latest Wage Price Index released by the Australian Bureau of Statistics (ABS).
And as a result Australia’s debt-to-income ratio is astronomical. The ratio of household debt to disposable income has almost tripled since 1988, from 64 per cent to 185 per cent, according to the latest AMP. NATSEM Income and Wealth report.
What this means is that many Australian households are highly indebted, thanks in large part to the property market, without the income growth to pay it down.
“The ratio of debt to income is as high as it’s ever been in Australia and there are some households that are very, very exposed,” Mr North said.
THE YOUNG AND RICH MOST AT RISK
This finding will come as a surprise: young affluent homeowners are the most at risk — it is not just a problem with struggling families on the urban fringe. When it comes to this segment of the market, around 70 per cent would be in difficulty with a 0.5 per cent or less rise. If rates were to hike 3 per cent, bringing them to around the long term average of 7 per cent, nine in ten young affluent homeowners would feel the pressure.
“It is not necessarily the ones you think would be caught. And that’s because they are actually more able to get the bigger mortgage because they’ve got the bigger income to support it.
“They have actually extended themselves very significantly to get that mortgage — they have bought in an area where the property prices are high, they have got a bigger mortgage, they have got a higher LVR [loan-to-valuation ratio] mortgage and they have also got lot of other commitments. They are usually the ones with high credit card debts and a lifestyle that is relatively affluent. They are not used to handling tight budgets and watching every dollar.”
And while the younger wealthy segment of the market being most at risk might not be of that much importance compared to other segments, Mr North said what is concerning is the intense focus on this market.
“Any household group that is under pressure is a problem for the broader economy because if these people are under pressure they are not going to be spending money on retail and the broader economy,” Mr North told news.com.au.
“The banks tend to focus in on what they feel are the lower risk segments and the young affluent sector has actually been quite a target for the lending community in the last 18 months. Be that investment properties or first time owner-occupied properties, my point is there is more risk in that particular sector than perhaps the industry recognises.”
TOUGHER HOME LOAN RESTRICTIONS NEEDED
Now an argument is mounting that Australian banks need to toughen up their approach to home lending.
“I think we have got a situation where the information that is being captured by the lenders is still not robust enough. I am seeing quite often lenders willing to lend what I would regard as relatively sporty bets … I’m questioning whether the underwriting standards are tight enough,” Mr North said.
This includes accepting financial help from relatives for a deposit, a growing trend among first home buyers.
“The other thing that I have discovered in my default analysis is that those who have got help from the ‘Bank of Mum and Dad’ to buy their first property are nearly twice as likely to end up in difficulty … It potentially opens them to more risk later because they haven’t had the discipline of saving.”
News.com.au contacted several banks for comment on whether they think a rethink of their underwriting standards is needed. Only one lender, Commonwealth Bank, agreed to comment, but remained vague on the topic.
“In line with our responsible lending commitments, we constantly review and monitor our loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs. Buffers and minimum floor rates are used when assessing loan serviceability so it is affordable for customers,” a CBA spokesman said in an emailed statement.
But Mr North said something needs to be done before we find ourselves in a property and economic downturn.
“I’m assuming that with the capital growth we have seen in the property market, it will allow people who get into significant difficulty to be able to get out, however, it’s the feedback concern that I’ve got.
“If you have got a lot of people in the one area struggling with the same situation, you might see property prices begin to slip. If we get the property price slip, and we get unemployment rising and interest rates rising at the same time, we have that perfect storm which would create quite a significant wave of difficulty.
“We need to be thinking now about how to deal with higher interest rates down the track. We can’t just say it will be fine because it won’t be,” he told news.com.au.
Originally Published: http://www.goldcoastbulletin.com.au/
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