Understanding limited recourse borrowing arrangements

A self-managed superannuation fund (SMSF), generally speaking, is not able to borrow to acquire assets. The rationale is that superannuation is meant to be a relatively conservative investment vehicle, and borrowing can put the fund at risk.

An example of this risk at work was seen during the global financial crisis (GFC) through margin lending schemes where people borrowed money to invest in shares. When the GFC hit, people not only lost the value of their initial borrowings but had to make up for the loss in value of the shares they had purchased. This had a severe effect on a lot of people’s finances.

Given that the market operates in cycles, there is every chance you will see a number of market downturns in your lifetime. If you borrow at the wrong time it can be devastating.

Prohibition on borrowing

Superannuation law formally prohibits a superannuation fund, including an SMSF, from borrowing or maintaining a borrowing. There is however a limited exception that allows trustees to borrow money through a “limited recourse borrowing arrangement” (LRBA).

LRBAs are subject to the certain conditions. These are:

  • the borrowed money is used to buy a “single asset” that is held on trust so that the trustee of the SMSF receives the beneficial interest and right to legal ownership of the asset (or any replacement asset) that occurs after the loan is repaid
  • the lender’s recourse (what they can claim against you on default) is limited to the rights relating to that single asset — that is, they can’t get access to other assets in the fund to make up a shortfall (hence the name “limited recourse”), and
  • the asset (or its replacement) must be one that is permitted by certain super rules.

Other requirements

The relevant investment must not only be allowed by the super rules but also by the fund’s trust deed and investment strategy.

Also the borrowed money can only be used to buy one asset per borrowing arrangement, with the bank or lender only able to claim against that asset in case of default. Even though the lender is only able to use the asset bought to repay outstanding money in the loan and not the other assets of the fund, most lenders will require some kind of personal surety outside of your super assets before they will lend you the money.

When you use an LRBA, you can acquire what is known as a “single acquirable asset” (though this can be a bundle of shares or units — you don’t need a separate LRBA for each share you buy, but these need to be of the same type and in the same entity). You can also use the money borrowed to pay for costs in connection with the borrowing and costs of acquiring the asset (such as stamp duty).

Borrowings cannot be used to refinance an existing super fund property or improve or change an existing property held within the super fund — that is, an asset held by the fund before the LRBA was entered into.