Can trusts increase burrowing capacity?

Yep – this old chestnut!

I suggest you search though the forums as plenty has been written on it.

Highlights:

> If you have maxed out your borrowing in your own name then you won’t be able to leverage your borrowing ability elsewhere. Maxed is maxed.

> As Terry has said, Trusts cannot borrow in their own right (they are not separate legal entities as such), but the Trustee usually can (see Trust deed permissions)

> Trusts cannot distribute losses, so buying -vely geared property in a trust has limited benefit as the loss is ‘locked’

> -vely geared property in a trust will require personal guarantees from the Trustees if individuals, or directors of corp Trustee (if company), so this will still hurt your personal borrowing ability

> Only +vely geared property that has sufficient cashflow and credit standing meet the serviceability requirements of the loan will meet the requirements I mentioned in the book. And then only if you have someone from the lender / mortgage broker who knows what they are doing.

Example: I am about to buy a $1m commercial property with $100k net income. if I buy this in a new trust, then the loan will either not need a guarantee as it can stand on it’s own, or if it does, there is no impact on my personal borrowing ability as the property is self-liquidating (i.e. loan repayments fully met from income).

Need further help? Make an enquiry and speak to Chris Berry: http://www.propertyinvestingfinance.com

Bye,

• This reply was modified 3 years, 8 months ago by  Steve McKnight.

Here is a copy of an article that I wrote back in 2016:

Trust Strategies to Increase Borrowing Capacity
Here are a few of examples of how using a discretionary trust can increase borrowing capacity.
Example 1

Trust is set up to own property. Property increases in value. But the director of the trustee has suffered a credit blemish and no lender will lend.

Solution – change directors!
Get legal advice first!

Example 2

Trust is set up to own property. Property increases in value. But the director of the trustee no longer is able service with just his income and the trusts rental income.
Solution – bring the spouse on as a guarantor. You could do this with properties in personal names as well.
Solution 2 – bring a friend on as a guarantor. The friend may need to be a beneficiary of the trust and/or a director of the trustee.

Get legal advice first!
Example 3

Trust is set up to own property. Property increases in value. The director of the trustee suffers a court judgment and no lender will lend to him. If this was a property in his own name he would be stuffed for 5 years but with a trust there is a simple solution:
Solution

Director causes spouse/friend to be appointed director and then resigns. The loan is then refinanced with the new director providing a personal guarantee.
Get legal advice first!
Example 4

A trust is set up to own property and loans are obtained with personal guarantees from person A who is the director of X Pty Ltd the trustee.
After a while person A sets up a new trust with a new company Z Pty Ltd as trustee and himself as director. Person A does not tell the new lender about the personal guarantees he has given to the lender for the first trust. Since the new company, Z Pty Ltd, is a separate legal entity to the first company X Pty Ltd, its debts need not be disclosed.
If the lender asks person A about any personal guarantees he has given he should disclose those guarantees. If the lender does not ask person A need not disclose. Thus the borrowing capacity could be increased by setting up new entities.
This method has been promoted by a certain property author and criticised by various brokers, including myself in the past because the new lender would know about the personal guarantees given by person A as there would be a record on A’s credit file. However as time passes these credit file hits become less of an issue and will disappear from the file after 5 years.
Get legal advice first!

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But before doing anything described above each person and the trustee should seek legal advice as there are various legal implications involved.
To be balanced, here are some ways a trust can hinder borrowing capacity.
Example 5

The property’s rent is less than the interest on the loan.

Lenders will not be able to use negative gearing addbacks because the trust has no other income and it does not pay tax. This will reduce serviceability slightly.
Example 6

The property has a taxable loss of $10,000 per annum.

This could potentially save the individual $5,000 per year in tax but would result in a $10k carried forward loss for the trust with no immediate tax benefits unless the trust had other income.

This has 2 effects

Less cash to pay down non-deductible debt
Less cash flow making it slower to build equity.

Trusts are complex legal arrangements so see your lawyer before attempting any of this on your own.

Example 9
Trustee company owns property and suffers a court judgment. Lenders will no longer lend.

Solution
Appointor can appoint a new clean company as trustee.

Yes it would as it is your debt. best to have a company as trustee.

You would have an added issue too in that a trust is not a legal entity but is a tax entity, so could the trust claim the interest on your loan? I have a private ruling application in with the ATO at the moment asking this very question.

I also don’t understand what you are saying about the taxable loss.

They are not your assets if held on trust. You might control the trust and be a potential beneficiary though, but just remember this control is only temporary.

If you are paying money, even from a loan account, to the trust then that is something that will work against you in servicing – whether there are losses or not. You will also have some legal and tax issues as well.

An asset held by a trustee of a discretionary trust is not an asset that you own, so it is the same as paying off someone else’s loan. It has various consequences so best to seek legal advice. One strategy might be to lend your cash interest free to the trustee instead and let them pay off the loan with the loan from you. Another may be to gift to the trustee.