Related Party LRBA Refinancing: Maximise SMSF benefits with commercial lenders
With the economy in constant flux, SMSF trustees holding related party Limited Recourse Borrowing Arrangements (LRBAs) have been grappling with rising interest rates, which have jumped exponentially over the past 12 months due to a dissonance between commercial bank rates and the safe harbour rules.
However, there’s an opportunity available that may save interest payments while remaining compliant.
SMSFs can now explore the possibility of related party LRBA refinancing with commercial lenders. This aims to enhance savings on interest payments while ensuring compliance with the dynamic regulations.
The rising interest rates challenge
SMSFs who comply with the safe harbour terms outlined in PCG 2016/5 – Income tax arm's-length terms for limited recourse borrowing arrangements - have been hit with a 3.5% interest rate increase due to monetary policy rate hikes in the 2023 financial year.
Interest rates have surged from 5.35% to 8.85% for real property and 7.35% to 10.85% for share-based LRBAs in the 23/24 financial year. These rate hikes have significantly impacted SMSFs relying on safe harbour provisions for their LRBAs.
As you can see from the table below, related party interest rates have remained constant since 2015 averaging around 5.80% with a sharp rise in the 23/24 financial year.
ATO Self-managed super fund LRBA interest rates:
REAL PROPERTY (%)
LIMITED SHARES OR UNITS (%)
Now is a good time for SMSF trustees to reevaluate whether structuring a related-party LRBA under PCG 2016/5 is still the best option. The sudden increase in interest rates, which are beyond the control of trustees, is prompting a growing number of them to explore alternative financing avenues.
Safe harbour provisions: A double-edged sword
The safe harbour provisions within PCG 2016/5 offer some respite to SMSFs by allowing them to lock in interest rates for up to five years, providing relief from monetary policy hikes. This lifeline benefited those who recently established their LRBAs under the safe harbour umbrella prior to the RBA beginning rate hikes.
However, as the economy comes to terms from the fallout of the COVID-19 pandemic, these funds face the prospect of interest rates rising by nearly 3- 4%, depending on when they locked in the safe harbour interest rates.
Furthermore, straying from the safe harbour terms outlined in PCG 2016/5 can attract the attention of an ATO audit which can lead to heavy consequences if found to be non-compliant. Income generated from the asset may be taxed as non-arm's length income (NALI), subjecting the fund to higher tax rates. Therefore, SMSFs with related party LRBAs are best to remain within the safe harbour provisions to avoid attention from ATO auditors.
Related party LRBA refinancing: Exploring commercial lender options
Commercial banks are offering a ray of hope in light of these challenges. SMSFs now have the opportunity to refinance their related party LRBAs with commercial lenders at reduced interest rates.
It's important to note that SMSF loan restructuring to a commercial lender's services requires trustees to demonstrate their ability to maintain repayments and meet the bank's compliance requirements. This includes providing financial documentation, supported by appropriate evidence, to prove the fund's capacity to service the loan.
Daniel Lanna, a Findex Senior Partner in Lending & Finance provides insight on the current commercial market for LRBA’s and interest rates;
Many clients view their LRBAs as a ‘set and forget’ product, meaning that once in place, the loan pricing/margin was never reviewed. More so with the lenders pulling out of this market, these loans have quietly been rising, unchecked to rates of near 10%. While this also falls to the borrower to review, it is almost a way for these banks to politely remove them off their lending books.
The remaining funders of LRBA products in the market have invested significant resources in improving their policies, products, and processes to be able deliver a simpler, more cost-effective LRBA product to the consumer with rates between 6.5 - 7% for residential securities and 7-7.5% for commercial properties.
This interest rate differential between the safe harbour rates equates to quite significant savings:
Example – Loan of $500,000
1% = $5,000 pa saving
2% = $10,000 pa saving
3% = $15,000 pa saving
This significantly increases on higher loan balances, which is money that could be coming off your principal, creating equity and building your investment portfolio.
Speak to a Trusted SMSF Adviser
SMSFs holding related party LRBAs find themselves at a crossroads. Although the safe harbour provisions provided by PCG 2016/5 offer much-needed SMSF interest rate relief to trustees by allowing them to lock in interest rates for a limited period, there are limitations. The sharp increase in interest rates that may occur at the end of the fixed-rate period can significantly impact the financial stability and cashflow of the fund.
Trustees can refinance with commercial lender options. This option offers potential interest savings and reduced repayments while ensuring compliance with commercial lending standards.
At Findex, our collaborative approach to financial services ensures we meet your unique financial needs. Our SMSF experts can help you stay informed about changes in the financial landscape and regularly reassess your fund's financial strategies to navigate related party LRBAs in the current economic climate.
The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex Group Limited.
This article contains general information and is not intended to constitute legal or taxation advice. If you need legal or taxation advice, we recommend you speak to a qualified adviser.
The title 'Partner' conveys that the person is a senior member within their respective division and is among the group of persons who hold an equity interest (shareholder) in its parent entity, Findex Group Limited. The only professional service offering which is conducted by a partnership is external audit, conducted via the Crowe Australasia external audit division and Unison SMSF Audit. All other professional services offered by Findex Group Limited are conducted by a privately-owned organisation and/or its subsidiaries.