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If you’re borrowing money to purchase an investment property, you may be able to take advantage of the many benefits offered by a trust home loan. Borrowing through a trust offers tax advantages, asset protection and secure succession planning for the future, so it’s an option worth considering for many borrowers.
However, trust home loans can be quite complex, so you’ll need to compare a range of trust borrowing options to ensure that you get a loan that’s right for your needs.
What is a trust?
A trust is an arrangement that makes it possible for a company or person to own assets on behalf of another person, a family or a group of people. The party that owns and controls the asset is called a trustee and is usually a trustee company or an individual, while the person or people for whom the property is owned are referred to as the beneficiaries of the trust.
As part of the arrangement, a ‘trust deed’ governs the role of the trustee, setting out any rules the trustee must follow and the details of how any profits will be distributed amongst the trust’s beneficiaries.
How do trust home loans work?
To take out a trust home loan to buy a residential property, you’ll need to set up a trust. This could be a family trust, a unit trust or even a self-managed super fund (SMSF) trust. Under such an arrangement, the property will be held by the company or person that acts as the trustee. The trustee takes up the home loan and guarantees its repayment, offering protection for the assets owned by the beneficiaries.
The homebuyers become the beneficiaries of the trust arrangement, and the trustee takes out the home loan on their behalf. As the homebuyers don’t legally own the property they are protected from any liability if loan repayments cannot be met, while there are substantial tax benefits to be had thanks to a 50% exemption from Capital Gains Tax (CGT).
However, obtaining finance for a home purchase through a trust company usually takes a lot longer than taking out a normal residential home loan as there are more parties and paperwork involved.
What types of trusts are available?
While there are many different trust types and structures available, not all of these will be accepted by lenders. In fact, there are some lenders who won’t offer any loans to trusts at all.
However, many Australian lenders will consider offering home loans to the following types of trusts:
Family Trusts or Discretionary Trusts
A discretionary trust is the most common type of trust available. It is typically established to hold the assets and/or businesses of a family. This allows the family to enjoy a range of tax benefits and also protect their assets from any borrowing liability.
As long as the trust rules are followed at all times, the trustee can distribute income and assets from the trust to the beneficiaries however they like – in other words, distribution can be done at the trustee’s discretion. For example, the trustee might choose to distribute a large portion of the income from the trust to younger family members with lower taxable incomes, thereby resulting in tax benefits.
A family trust home loan is a flexible borrowing arrangement that can be tailored to suit your needs and will most likely give you access to loans from a wider range of lenders.
A unit trust is set up in a similar fashion to a company, where the property the trust owns is split up into a number of shares called units. The number of units each person holds then determines their voting power and their entitlement to income and capital gains from the trust.
If you want, units in a trust can be split into different categories, such as income units and capital units. Unit holders can also be individual people, companies or discretionary trusts.
Unit trusts generally do not offer as many tax benefits as family trusts, nor do they offer the same level of asset protection. They’re best set up for a group of people who are not family members.
A hybrid trust combines the features of a discretionary trust with those of a unit trust. Hybrid discretionary trusts are more common than hybrid unit trusts, and they’re set up to allow beneficiaries to take advantage of the best features of each type of trust. For example, the trust can be divided into units while income can also be distributed to beneficiaries at the trustee’s discretion. Hybrid trusts are also commonly referred to as property investor trusts.
Unfortunately, many lenders do not offer loans to hybrid trusts.
This type of trust can be set up to help people manage their superannuation. While it receives employer contributions like any regular super fund, the SMSF trustee, which is normally you, has control over how your super balance is invested.
Some Australian lenders now offer SMSF trust loans to borrowers who want to invest in residential property. These limited recourse loans attract higher interest rates than normal loans and typically have a maximum LVR of around 70%.
What types of loans can you access?
- Fixed rate home loans. These loans carry a fixed interest rate for a fixed period. In most cases, limited extra repayments and offset accounts may also be available.
- Variable rate home loan. These loans offer a flexible interest rate that can go up or down depending on prevailing market rates. These loans may be cheaper than a fixed rate if market rates go down, and usually offer additional features such as the ability to make extra repayments without penalty and an offset account.
- Basic home loan. Such loans only have basic features, making them more affordable and easy to manage. If you want a simple loan with fewer features, waived application fees and a low ongoing rate, then a basic home loan may be right for you.
- Low Doc home loan. Low documentation home loans are designed for self-employed borrowers who have fluctuating incomes and who may not have the documents to easily prove their incomes. By signing an income declaration form you can access such a home loan, though you may have to pay a higher ongoing rate and fees.
How to compare home loans when borrowing through a trust
- Lender. You want a lender that understands your situation, along with the other members of the group. As a group you want a lender who has the experience of managing these types of loans, and can provide the legal guidance you need.
- Loan features. The type of features you go for should be determined by your financial needs, and also your need for flexibility in making repayments or accessing funds. You should remember that more features could increase the cost of the loan, so choose the features that suit you best. Some of the features available to you can include an offset account, extra repayments and a redraw facility.
- Interest rate. The interest rate is one of the major factors that affects the cost of a home loan, so you should shop around to ensure your lender offers you a competitive one. Other considerations such as getting protection from fluctuating rates or going for a variable rate mortgage with more features are some of the things you should examine when considering the type of home loan you want.
- Repayments. Having a home loan with repayments that suit your income is of great importance. If you prefer to have the security of knowing exactly how much your repayment will be each month, then a fixed rate mortgage would suit you. A variable rate mortgage may offer an option to make extra repayments, so you might be more suited to it if you are expecting extra income in the near future.
- Fees. The fees that come with setting up a mortgage and monthly account-keeping charges could end up raising the cost of your home loan, so be sure to compare different products so as to find one that you can comfortably carry.
Pros and cons
- Tax benefits. Borrowing through a trust for your home can yield major tax benefits by letting you distribute investment income amongst members of your family or different individuals. This allows you to have lower tax incomes and benefit from lower tax margins. You can also benefit from a 50% income tax exemption from capital gains tax for individuals who own property through a trust.
- Asset protection. Trusts offer the ultimate protection from any liabilities that come with life events such as being sued or getting divorced. As the property is held by the trustee, will you can enjoy the benefits of a property investment without having it in your name.
- Estate planning. A trust effectively enables you to pass on your assets to future generations without paying heavy taxes or having to cope with estate disputes.
- Complex. Trust home loans can be complex and confusing to set up. As a result, many lenders tend to avoid these types of loans.
Tips to find the best trust home loan
- Documents needed. In order to apply for a trust home loan you will need to provide identification for all trustees, directors of trustees and beneficiaries of the trust. A certified copy of the trust deed will also need to be included along with tax returns for the trust.
- Not all lenders. Because they’re more complicated than ordinary loans and often have unique legal issues attached, many lenders simply avoid trust home loans altogether. Shop around to find a lender that is willing to offer financing to trusts.
- High fees. Because of their complexity and the increased paperwork involved in their setup, trust loans tend to attract higher fees than ordinary home loans.
- Ask a mortgage broker. Many bank managers and lending staff don’t understand how trusts work and don’t have any knowledge of the ins and outs of trust home loans. Ask an experienced mortgage broker to explain the finer points of a trust home loan and help you decide whether it is the right borrowing option for you. If you do decide on a trust home loan, a mortgage broker will be able to help you structure the loan so that you can take advantage of any available tax benefits.
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