Have you ever thought about owning property through a trust, such as a Self Managed Super Fund (SMSF)? Trusts can be a strategic choice for asset protection, tax efficiency, and succession planning, but borrowing with a trust has its own unique complexities. Here’s a clearer look at the options and considerations.
What Is a Trust?
A trust is a legal structure where a trustee (an individual or company) holds and manages assets for the benefit of beneficiaries. The rules for managing the trust are set out in a trust deed, which governs how assets and income are distributed. Here are the most common types of trusts used when it comes to property investment and borrowing:
Types of Trusts Used for Borrowing
- Family (Discretionary) Trusts
- Purpose: Commonly used to hold assets for a family, offering flexibility in distributing income and capital gains to beneficiaries.
- Asset Protection: Provides robust asset protection, as assets in the trust are legally separate from the personal assets of beneficiaries. However, lenders typically require personal guarantees, so some level of risk remains.
- Tax Benefits: Trustees can distribute income in a tax-effective way, such as splitting income between spouses to lower the overall tax burden. Note that tax rules for minors are strict, with distributions to children under 18 taxed at the highest rate.
- Limitations: You can’t use negative gearing to offset personal income, and losses are trapped within the trust. It’s also more challenging to change trustees without incurring costs.
- Unit Trusts
- Purpose: Works similarly to a company, with assets divided into units that represent ownership shares. Useful for investments involving unrelated parties or when multiple families are involved.
- Distribution: Income and capital gains are distributed based on the number of units held, which means less flexibility compared to a Family Trust. However, if a discretionary trust holds units in the unit trust, some flexibility in income distribution can be achieved.
- Asset Protection: Provides less protection than a Family Trust. If a unit holder becomes bankrupt, their units may be sold to satisfy creditors.
- Suitability: Often used in joint ventures or investments involving business partners, where ownership needs to be clearly defined.
- Hybrid Trusts
- Purpose: Combines elements of both discretionary and unit trusts. Designed to offer initial tax benefits, such as claiming interest deductions for negatively geared investments, while retaining the flexibility of a discretionary trust later on.
- Structure: Initially, individuals borrow in their own names to buy units in the trust, with the trustee then using those funds to purchase the property. The trust can later transition into a standard discretionary structure as the investment becomes positively geared.
- Challenges: Hybrid trusts are less common and often harder to finance, with fewer lenders willing to approve loans.
- Self Managed Super Fund (SMSF) Trusts
- Purpose: A trust specifically designed to manage your own superannuation investments, with strict rules around borrowing and investment.
- Structure: The SMSF Trustee borrows funds to purchase an investment property, with a separate security custodian holding the property in trust for the SMSF. The loan is typically “limited recourse,” meaning lenders only have rights to the property, not other SMSF assets.
- Costs and Complexity: Setting up an SMSF structure involves higher legal and administrative costs, but it allows for direct control over investment decisions. Loan-to-value ratios (LVRs) are typically lower, and interest rates may be slightly higher.
- Lending Options: A select group of lenders offers SMSF loans, often at rates 0.5% to 1% above standard home loans.
Why Borrow Through a Trust?
- Asset Protection: Assets held in a trust are legally separate from beneficiaries, protecting them from personal liabilities. Lenders still require personal guarantees, but other creditors cannot access the trust’s assets.
- Tax Efficiency: Trusts can help distribute income strategically among beneficiaries, reducing the overall tax burden. The 50% Capital Gains Tax exemption for trusts (not companies) is a significant advantage.
- Succession Planning: Trusts allow for a smoother, tax-effective transfer of assets to the next generation, avoiding complications that often come with inheritance.
Trust Lending: What You Need to Know
Borrowing with a trust isn’t straightforward. Many lenders are unfamiliar with trust structures and may direct you to commercial lending, which often comes with higher rates and fees. At Stellar Finance Group, we understand the ins and outs of trust lending and can guide you to the best options available.
- Family Trusts: Most flexible but limit negative gearing benefits.
- Unit Trusts: Useful for non-family investments but less flexible with distributions.
- Hybrid Trusts: Few lenders will finance these, but they offer a creative structure for maximizing tax benefits.
- SMSF Trusts: Growing in popularity but come with strict regulations and setup costs.
Final Thoughts
If you’re thinking of borrowing with a trust, make sure to weigh the benefits against the complexity. Always consult with legal and tax professionals to tailor the right strategy for your situation. Need expert guidance on trust loans? Reach out to Stellar Finance Group today!
How Do Trust Home Loans Work in Australia?
A trust home loan is a loan arranged through a trustee to purchase or refinance property held in a trust structure. Depending on the trust and the lender, finance may be available for residential investment properties, commercial properties or other eligible assets.
Unlike a standard home loan, trust lending involves additional checks on the trust deed, trustee, beneficiaries and proposed loan structure. Lenders may also require personal guarantees.
What Do Lenders Look for When Assessing Trust Loans?
Lenders generally review the trust deed to confirm the trustee has authority to borrow and provide security. They also assess the financial position of the relevant borrowers and guarantors, the purpose of the loan and the property being financed.
Requirements vary between lenders, so the right finance option depends on the trust structure and individual circumstances.
Frequently Asked Questions About Borrowing With a Trust
Can a trust borrow money to buy property?
Yes. In Australia, a trustee may be able to borrow money to purchase property on behalf of a trust, provided the trust deed permits borrowing and the lender accepts the structure. The trustee is generally the legal borrower acting in its capacity as trustee.
Can a family trust get a home loan?
A family trust may be eligible for property finance through its trustee. Approval depends on the trust deed, income, existing debts, security, guarantees and the lender’s policies. Some lenders have more experience with family trust home loans than others.
Are trust loans different from standard home loans?
Yes. Trust loans usually involve additional documentation and assessment because the trustee is borrowing on behalf of a trust. Lenders may request a certified trust deed, trustee details, financial information and personal guarantees. Available loan products and lending terms can also differ.
Which banks offer loans to trusts in Australia?
Some banks and specialist lenders consider loans to trusts, but their requirements vary. Eligibility can depend on whether the trust is discretionary, unit or another structure, as well as the property type and borrowing purpose. A mortgage broker can help identify lenders willing to assess the proposed arrangement.
How is borrowing capacity assessed for a family trust?
Lenders assess relevant income, expenses, liabilities and existing commitments. They may also consider the financial circumstances of trustees and guarantors. Using a family trust does not automatically increase borrowing capacity, and lenders may assess existing guarantees and related debts when considering an application.
Can you refinance a property held in a trust?
Refinancing may be possible where the lender accepts the trust structure and the application meets its requirements. The lender will generally review the trust deed, current loan, property value, serviceability and any required guarantees. Legal and tax advice may be appropriate before changing an existing arrangement.
Can a hybrid trust obtain a home loan?
Financing a hybrid trust can be more complicated because of its combination of discretionary and unit trust features. Lender acceptance varies, and the trust structure may require specialist legal and tax advice before finance is arranged.
Does borrowing through a trust offer tax benefits?
The tax treatment depends on the type of trust, the property, the purpose of the borrowing and applicable tax rules. Benefits are not automatic, and trust structures can involve additional costs and restrictions. An accountant or qualified tax adviser should assess the circumstances before any decision.
