Loan Tip: The so-called ‘Unlimited Borrowing Capacity’ Strategy

There is a lot of misinformation out there about using trusts to get ‘unlimited serviceability’. Here is my take as a lawyer, tax adviser and mortgage broker.


Companies are separate legal persons, separate legal entities. They can enter contracts like an individual can and this includes contracts to borrow money. They are separate legal entities to their directors and shareholders.


Trusts are not legal entities at all, but relationships. A trust cannot enter a contract for example. The trustee would be the one entering the contract.


With borrowing money to buy property the lenders will look at the income of the borrower and, sometimes, the income of the guarantors when working out borrowing capacity.


Company A can be set up to own property. It could be acting in its own right (meaning not acting as trustee) or it could be acting as trustee. It doesn’t really matter for this strategy.


Company A would borrow to buy the property. Company A would be new and have no assets so any lender would require a personal guarantee from someone. Usually all directors would be required to give a personal guarantee – sometimes the shareholders too.


Company A gets the loan with Director A giving a personal guarantee. The borrower is Company A. Director A is not a borrower and they are not liable for the debts of Company A, but the loan is a contingent liability with Director A becoming liable if Company A defaults on the loan.


Serviceability largely depends on the income of Director A.


Now Company B is set up. Director A is also the sole director of Company B.


Company B wants to borrow money to buy a property. The lender will work out the serviceability for Company B based on Company B’s income plus the income and liabilities of Director A.


The debts of Company A have no connection with Company B. Company B could generally not be liable for anything Company A does (there are some exceptions though). So for serviceability purposes the debts of Company A are not taken into account.


But Director A has guaranteed the loan of Company A. Most lenders will take that guarantee into account as a debt of Director A, even though Director A is not liable for the debt until Company A defaults.


However, there are several lenders out there that will disregard the debts guaranteed by Director A for other entities.


If this happens then Company B’s borrowing capacity would be given a ‘boost’ because Director A’s debt levels, for servicing, will reduce.



The general requirement for a lender to disregard a personal guarantee from Director A is that the company that the guarantee relates to is ‘self sufficient’ and doesn’t need any injection of funds from Director A, or others. In the first year this is often evidenced by a letter from the Company’s accountant. In the second and subsequent years it would be evidenced by the tax returns for the company or trust (to confuse things a trust is a separate entity for tax purposes).


The policies of the lenders on this sort of thing are rather vague. This is generally approved as an exception to policy. It is therefore difficult to pin point what ‘self sufficient’ actually means and it will largely depend on how the deal is argued by the borrower’s broker.


So what does all this mean?


Company A could borrow to buy one property,

Company B could then borrow to buy another without the debts of Company A counting for Company B’s loan

Company C could then borrow to buy another property without the debts of either Company A or Company B counting for the servicing on Company C’s loans.


Naturally there is a heap more to this strategy and it is not one that I am recommending readers rush out and jump into.


Firstly, you would need to get both legal and tax advice on using a company to hold property or a company acting as trustee. There is a lot to consider besides the loans.

The borrower will have to consider the source of the deposits. Lots of issues when Company A is borrowing but the deposit will be used by Company C for example – legal, tax and loan issues.


There are a lot of sub-strategies to consider incorporating as well such as guarantor choice, offset accounts, related party loans, bucket companies, holding companies etc.

Should you implement this strategy? The starting point is 'no' unless convinced otherwise. It is a long term strategy though and setting up the foundations now may help in years to come.

 

Good summary. I find many people think a trust / company is a magic bypass to loan capacity or servicing. Negative gearing could even be at risk. And lenders dont commonly just ignore the fact the taxpayer entity may have a cashflow shortfall.

 

Any strategy that heavily relies on lender policy should be considered fairly high risk. This one is expensive to hold, and also only works when properties are self sufficient - which is pretty bloody hard to come by, especially with rates the way they are.

Sounds awesome....kinda isn't, for most people.

 

Yep, good luck finding a positive cashflow property at todays interest rates without putting about a 50% deposit down. Which eliminates half the benefit of property investing which is leverage.

 

It's not an 'unlimited' borrowing strategy. Lenders often ask for the trust financials anyway and most will be making a loss. That loss needs to be factored into the serviceability calculators. It's certainly a lot more favorable than applying debts with assessment rates to these calculations, but these losses do reduce serviceability and eventually it will run out.

The reality is that you might be able to get more money out of the banks, but the actual cost of holding properties in this manner becomes prohibitive. You might be able to get more serviceability, but it will reduce your cash flow.

 

Seems that more and more of those 'wealth creation' companies are advertising this as a strategy to their clients.

I reckon we'll see more lenders change their policy to eliminate this, it's getting harder to find accountants willing to write the letter required for this strategy too.

 

Yes letters are getting harder. I was recently asked to not mention other loans but to confirm the trustee had no liabilties. BUT it did have loan liabilities. I was told - Oh but the assets exceed liabiliies. I dont care. There were no 2023 financials and no other basis to address this. I said...I mention this or no letter. Its then the lenders job to assess that issue. If there is no issue with net assets or cashflow etc ....thats up to the lender not me. I was asked a week later again as the lender reduced borrowing capacity because of that property / loan. They were trying a new lender.

Not my role to mislead lenders. NOT saying something can be as misleading as saying something that is incorrect

I have noted lenders are also checking such letters. I have been called twice in recent months to check a letter I issued was complete and issued by me.

 

It wouldn't be used just for serviceability, but careful structuring can assist years down the track as well. It is also possible to make properties self sufficient very quick, in some instances, without paying down the loans.

 

Absolutely - it makes sense if there's other reasons to invest in multiple structures. Just not necessarily if the sole reason is serviceability. I think it's being spruiked as the answer to everyone's servicing prayers right now bc it's so tough atm, but for most people it's either too late bc they're got too much in their personal names already, or just not as amazing as it's made out to be.

 

Its not necessarily about finding them today, but all property would become positively geared if you hold them long enough and then the strategy could come into play

 

If it was negative for last 5 years and become positive in 6th year. Is that enough? Or do lendgers want it to be positive for 2,3 consecutive years?

I know it depends the bank policy, in general are they asking only for the last financial year report?

 

The requirement generally is that the company or trust is self funding, and needs no outside injection of funds, either as a gift or loan. If you can demonstrate this it might work

 

With CBA often this goes to credit for approval - although it's now actually written in policy... here some of the notes

"Where the customer is a shareholder in a company, the company’s commitments do not need to be included in the application, however the loan repayments must be included in the income input."
"You are not required to verify/capture self-employed income where there is no reliance on salary and/or profits paid by the customer’s business or company. However you will need to confirm and include in the application comments that the business, from which the selfemployed income is derived, is trading profitably. For sole trader and partnerships only, you must ensure business liabilities have also been included for servicing. For companies, you are not required to include business liabilities for servicing.’"

 

Thanks @Terry_w for the explanation that was simple to understand the basics off.

Can see why many would not recommend this strategy in common strategy IPs but may have a place in particular circumstances,

As for self sufficiency is this the actual income> expenses of the company or the banks perspective? Eg rental income shading etc.

I guess even if the strategy works no negative gearing (company and the fact its self sufficient) and no CGT discount on sale. Maybe high yield low growth property. Guess not really a great property if low growth.

 

I do recommend this strategy, but not merely buying in a company or trust just for the sole reason of implementing this strategy.

Its whether the guarantor or someone else is needed to inject money into the trust or company or not.

Negative gearing can happen internally, and trusts get the 50% CGT discount on sale.
Even with a company owning in its own capacity the final CGT would not be 30% but could be much lower (or higher)
Tax Tip 287: How Capital Gains Through a Company can be Tax Free Tax Tip 287: How Capital Gains Through a Company can be Tax Free

 

1. It can potentially get you into financial stress and you could loose everything. Some people do make bad decisions and borrow more than they can afford, then complain when they get into financial stress.
2. It's very expensive to own properties via a trust structure. Everything costs more, you don't get the gearing benefits. It has a significant impact on cash flow.
3. It's not a reliable strategy. Often the decision to approve it comes down to an assessor rather than a concrete policy.

I do own properties in a trust and I can quantify the benefits to my own borrowing capacity. I can also quantify the downside.

My general recommendation is to employ trusts to meet other needs (if they exist), not as the focus of extending borrowing power.

 

People should understand that they don't own properties in a trust, or a company. With a trust the best you can do is to control it, but control is only temporary. They are not your properties.
With a company it is a separate legal entity and all you could potentially own is the shares of the company, but not the property itself. You wouldn't even have any equitable interest in the property. You couldn't put a caveat against it for example.

 

Yes...saying you own it only applies when YOU own it. When you wife owns it its not yours either. You can only influence and may control a trust, company,...harder with a wife. And control can be problematic. What happens if the trustee company is deregistered ? Who has the power of appointment for a trust ? And what happens if they die....

Many people will tell you "they"own a property in a company, trust etc but cant explain what happens if they die or become incapacitated. Some of the best trustee companies, trusts and companies may have automatic rules that deal with such control rather than waiting around for wills and probate etc

One of the major reasons a trust or company is used to own property is so that no individual owns the property. You may merely control it...for now.