Legal Tip 91: Structuring a Trust to Maximise Borrowing Capacity

A law/loans tip rolled into 1.

A trust is not a separate legal entity but is a relationship between the trustee and the beneficiaries. Therefore a trust cannot borrow!

It is the trustee that borrows money and does so in its capacity as trustee. Where there is an individual trustee the loan will be in the name of that person. Where there are 2 trustees the loan will be in both names. Getting a loan as trustee has basically the same consequences as getting a loan on your own. You will personally be liable for the debt and they loan will count as a debt when assessing further borrowings. The trustee will likely be indemnified out of the trust assets, but if they are not enough there personal assets will be exposed.

Where the trustee is a company a lender will not lend, usually, to a company without a personal guarantee by all the directors of a company. There used to be some lenders who did not require personal guarantees where the LVR was low, but most lenders will ask for one from all directors and sometimes from shareholders.

Since the lenders ask for personal guarantees from all directors the number of directors can be limited to reduce the need for giving guarantees. (this has other consequences such as control of the trust).

From a borrowing point of view the ideal trustee structure would be a company trustee with one director. This will limit the guarantor's to one person. Where this person does not have enough income to qualify for the loan then additional guarantors can be offered - if and when needed. This can be done without the additional person becoming director if the other person is a shareholder or a beneficiary of the trust.

Being a director is risky so should be avoided if possible for asset protection reasons. Most lenders would probably allow a spouse of the director to offer a guarantee if they are also beneficiaries of the trust. NOTE that structuring a trustee set up this way may be good for borrowing but there may be other disadvantages to the structure from a legal point of view so legal advice should be sought before decided in structure.

Also there are some lenders who insist on obtaining personal guarantees from all named adult beneficiaries of a trust. This is not good as additional guarantees may be required from persons who may not want to give guarantees and who may not even know of the existence of the trust. Other lenders require a letter from named beneficiaries stating that they have no objections to the trustee borrowing, again not good.

However not naming people in a trustee may, or may not have consequences as to who a beneficiary of the trust will be - so legal advice is essential.

 

Can we add or modify the beneficiaries after obtaining the loan without informing the lender?

 

Yes. But consider the legal implications.

 

....And possible tax implications for the trust !!

In QLD (especially) and elsewhere that could result in stamp duty. For income tax there could be issues with prior losses or even CGT.

I have rarely seen a lender require the borrowers in a disc trust sign a (???) that they would not vary the trust. Have seen it with companies and unit trusts a bit. Common with business loans. And as T says - The lender will have Director guarantees etc. Rule #1 of lenders is to take security and lots of it. Creditors may pursue the former trustee/s of a trust too. So variation wont necessarily mean non-involvement.

Arguably the bank ranks as first (secured) creditor and beneficiaries follow with the beneficiaries entitled to share of trust estate AFTER the directors indemnities are settled.

 

I know RAMS used to ask for a personal guarantee from everyone named in a trust.

St George used to ask for a letter from all named beneficiaries stating that they have no objection to the trustee borrowing.

But these requirements come and go as the lenders lawyers change.

 

Heya @Terry_w,
Sorry to bring up an old post but im just trying to research and understand how a trust could help in servicing?

Say my wife and I are both working and about to purchase an OO home.
We then plan on having a child not too long afterwards.

If I wanted to then purchase an IP I would of course be limited because we just lost a wage (assuming not planning on going back to work for a while).

Could a trust instead somehow be used?
For example if we purchased the OO in both our names. Then I set-up the trust and become the sole director and guarantor, would the lender assess my portion of the OO loan?

If so then what about if we purchased the OO in just her name (if she could service?) and then I set-up the trust. Would the lender assess my wife and kids as a living expense? And would they include the wifes loan in servicing?

Sorry for all the questions. Just trying to understand how people use trusts to help servicing and for future planning.

 

A lender will want a personal guarantee from all directors of the trustee company. The servicing will be worked out the same as if the person is borrowing in their own names. So if the person has a spouse this would be counted as would a dependant child.

 

@albanga from what I can gather you can add additional guarantors to the servicing equation, essentially adding more income, at a whim. The additional guarantors would need to be related to the trust in some manner.

The problem is each guarantee in this manner reduces that individuals servicing and also makes them responsible (in full) for the loan under most lenders policies. It would be silly to give a guarantee of this nature.

In the example you've outlined, there's no serviceability benefit in using a trust. More likely the trust will reduce your serviceability as gearing losses in a discretionary trust can't be credited against your personal income.

There are actually ways borrowing through trusts with corporate trustees that will increase your serviceability. The problem here is it takes an immense amount of planning, to the point where I've yet to meet anyone who plans far enough in advance to take advantage of certain loop holes in specific lenders policies to make it work. It also relies on loop holes, which makes it inherently unreliable.

I can thing of plenty of good reasons to use a trust, but serviceability and affordability isn't one of them.

 

Awesome post @Peter_Tersteeg!
Am I right then in assuming the bottom line when discussing trusts from a financial stand point is the potential taxation benefits (e.g for developing) and the benefits they have for distribution of income.

Whilst this in itself can assist with servicing (e.g distributing income to a low income earner). The trust itself doesn't offer any servicing benefits, if anything it can make it worse due to losing the benefits of negative gearing?

 

hmmm just thought about this a little more. What about if you wanted to renovate and flip or develop and sell (without holding any).

Would it be beneficial in this situation to say buy the OO solely under the wifes name so she has 100% of the debt.

Then use a trust with myself as the guarantor. I would need to take my wife and kids into the living expenses, but i wouldn't need to account for the OO debt.
Using my income I could then service the purchase and renovation/development and upon completion sell and distribute to my beneficiaries (myself and wife).

This would then avoid the issues you mention with regards to negative gearing and also assessment of all debt as the trust never really holds a property for longer than 1-2 years.

If this would work then i suppose what are some of the other disadvantages in terms of trusts and borrowing. From what i have read, the lender selection is minimised and you can also be charged a premium on the rate.

 

Is your wife working? If she's not, your income would be required to service the debt, so no real overall advantage as this needs to be considered when borrowing via the trust later on.

There's no overall serviceability benefit in dividing assets between husband and wife.

 

My wife is working now and could service an OO debt on her income, but we do want little kiddies soon enough. So thinking for future planning.

If I also went on the loan and then when it came time to purchase to renovate and flip I would likely find myself short due to having 100% of the OO debt.

I was thinking if she purchased the OO now, then down the track when she is not working I could purchase as a guarantor for a trust and whilst i would need to consider her and the little one as an expense, I would not have to account for the OO debt.

I understand this does then of-course raise the issue that if she is not working and i go and borrow as a trust, she still needs to service the debt!

 

You'd probably get away with it (assuming the debts could be serviced). I'm fairly certain lenders wouldn't quite see it that way if they knew about it however.

 

Taxation benefits is just one aspect.

But servicing is another. Trusts can improve servicing in many regards
- removing a credit impaired guarantor
- add people for serviceability
- removing people for serviceability
- distirbuting income for serviceability
etc

 

Yes this is basic loan structuring. Structure so only one person is on the debt and then the other person is clean from a servicing point of view. Your wife's loan is not going to effect your serviceability at all (unless you had guaranteed it).

 

This is how I structure the majority of my client's loans. Not sure why you think lenders wouldn't see it that way. A spouse is not legally responsible for the other spouse's debt.

 

Technically I agree with you on this point, but you may be walking a very fine line with the responsible lending legislation. The simple test of this is would the credit assessor approve the loan if they were aware of the spouses financial position? What would ASIC think about it?

I suspect this sort of thing is one of the primary reasons the CBA started asking for transaction statements earlier this year.

I'm certainly not above taking advantage of grey areas like this when there's other risk mitigants in place, but I don't think it's prudent to promote it as general advice.

 

This is no grey area but very clear. I have even done this with CBA recently with statements provided.

 

It is an interesting argument though and I do see @Peter_Tersteeg's point.

My wife can service a loan by herself now but when she takes maternity leave (whenever that is), then I will no doubt need to service that loan on her behalf. To be fair I imagine in most relationships this would also be the case. Yes an argument can be made for paid maternity leave, centrelink.etc. But let's not beat around the bush in saying in majority of cases the working partner is paying the mortgage.

If the loan is just under her name and then I go and get a trust structure with myself as the guarantor I would not need to declare her loan. This would drastically improve my servicing which would then allow me to borrow more money.
I would now be paying my new loan via the trust and also servicing my wifes loan as she is on maternity leave.

In this instance was the person on maternity leave still servicing their own loan? I would think some eyebrows would be raised if CBA saw the mortgage payments coming from another person?
But that said I suppose the husband could just transfer 6 months worth of payments in advance so when CBA look at the statements the mortgage was being paid from that persons account.

It is very interesting i must say!