Six tips for staying out of trouble with limited recourse borrowing arrangements

The SMSF Professionals Association of Australia has released a set of best practice guidelines on advice and lending practices for limited recourse borrowing arrangements (LRBAs) following criticism of the loans in the Financial System Inquiry.

National Australia Bank has agreed to adhere to the guidelines and SPAA is working with other lenders in the sector to try to win their support.

“We believe that by publishing these guidelines, and with NAB signing on and other major lenders in the pipeline (the major banks are estimated to have more than 85% of this market), the government and regulators can have a high degree of confidence that LRBAs are being used appropriately,” said SPAA chief executive Andrea Slattery.

LBRAs are loans that self-managed superannuation fund trustees can use to buy property and other assets through their funds.

The Reserve Bank of Australia warned in its submission to the Financial System Inquiry that increased borrowing through SMSFs warranted close monitoring due to the potential risks it posed to the financial system and individuals’ retirement incomes.

There were $2.72 billion worth of limited recourse borrowing arrangements in place at December 2013, the Australian Taxation Office reported. That was up from $515 million five years earlier.

The FSI interim report observed that if allowed to continue, growth in direct leverage by superannuation funds may create vulnerabilities for the superannuation and financial systems.

Slattery said a “tiny rogue minority” had been spruiking the borrowing facilities to SMSF trustees and that best practice guidelines were needed to ensure lenders and advisers took a responsible approach to the borrowing arrangements.

The lenders’ guidelines are intended to complement individual LRBA credit policy and practices. They require lenders to provide information to trustees about LBRAs and recommend they seek professional advice before entering into the arrangements, although they stop short of forcing trustees to seek advice.

The advice guidelines lists a series of topics advisers should cover in conversations with SMSF trustees about LRBAs, including risks, tax and what can and can’t be done with the property that secures the loan.

Slattery said the guidelines were intended to encourage self-regulation in the SMSF lending sector.

Six tips for staying out of trouble with LBRAs

1. Seek advice from an appropriately qualified and licensed SMSF specialist, accountant or financial adviser as to whether a LRBA is appropriate for you and how it would fit with your investment strategy
2. Seek legal advice on how to structure the loan and what is involved
3. Ensure the advisers and/or lawyers you speak to are independent of any property company that is advising you on a sale to minimise the chance of receiving biased advice
4. Understand your responsibilities in relation to the LRBA as distinct from the responsibilities of the lender and/or any adviser
5. Understand the rules about what you can and can’t do with a property bought with a LBRA
6. Understand the implications of the investment for your fund including factors such as tax, risk, diversification and time frames.