Borrower structures: individuals, companies and trusts

Why the borrowing entity matters

Before a lender looks at the property, it needs to know who is borrowing. The answer might be one person, a couple, a company, the trustee of a family trust or a trustee holding title for someone else. Each choice carries different consequences for personal liability, consumer protection, tax, duty and the paperwork the lender will want.

Borrowers often pick a structure because an accountant set it up years ago or because a friend uses one. That is a reasonable starting point, but property finance tends to expose the weaknesses of a structure that was never designed for borrowing. This lesson describes the common options in general terms so you can raise the right questions with your accountant, lawyer and lender.

Borrowing as individuals

The simplest borrower is a person, or several people, borrowing in their own names. The lender assesses each person's income, assets and credit history, and each signs the loan and any mortgage over property they own.

Where two or more people borrow together, they are generally jointly and severally liable. In plain terms, the lender can pursue any one of them for the entire debt, not just a proportion. Separation, death or a falling-out between co-borrowers does not divide the loan unless the lender agrees.

Individuals are also the group consumer credit law protects most directly. Lending to a person for personal, domestic or household purposes, or to buy, renovate or improve residential property as an investment, is generally regulated, bringing responsible lending duties and hardship rights. Business-purpose loans to individuals generally are not.

Borrowing through a company

A proprietary company is a separate legal entity. It can own property, sign contracts and borrow in its own name. Its shareholders are generally not liable for its debts beyond any unpaid amount on their shares, which is the point of limited liability.

For lenders, that same feature is the problem. If the company owns little apart from the property being financed, a shortfall on sale may leave nothing to pursue. So a lender to a company commonly takes:

• a registered mortgage over the property,
• a general security agreement over the company's other assets, recorded on the PPSR, and
• a director's guarantee from each director, sometimes supported by a mortgage over a director's own home.

The security types lesson explains each of these. Lenders will also search the company on the ASIC register, confirm who the directors and shareholders are, and ask for financial statements if income is relevant to the loan.

Borrowing through a discretionary trust

A discretionary trust, often called a family trust, lets a trustee decide each year how income and capital are distributed among a class of beneficiaries. A trust is a relationship, not a legal person, so the trustee is the one that buys property, signs the loan and grants the mortgage.

Why corporate trustees are common

A trustee is personally liable for debts it takes on for the trust, with a right to be reimbursed from the trust's assets. If individuals act as trustee, their own assets sit behind those debts. A corporate trustee, a company set up solely to act as trustee, keeps that exposure inside the company. It also makes changes of control simpler, because directors can change without moving title to the land.

The protection is narrower than it looks when borrowing. Lenders usually ask the directors of a corporate trustee to sign personal guarantees, which brings personal liability back for the loan itself.

What lenders check in the deed

Lenders and their lawyers read the trust deed closely. They generally want to see:

• the original deed and every later variation,
• evidence that the current trustee was validly appointed,
• powers allowing the trustee to borrow, mortgage trust property and give security for others,
• the vesting date, after which the trust ends, and
• who the appointor is, because that person can usually replace the trustee.

Missing variations or a defective change of trustee are common causes of last-minute delay. Gathering these early, using the preparation checklist, saves time.

Bare trusts

A bare trust is one where the trustee holds legal title for a beneficiary who is absolutely entitled to the property and can direct what happens to it. The trustee has no discretion of its own.

Bare trusts appear most often in self-managed super fund borrowing. Under a limited recourse borrowing arrangement, a holding trustee keeps title while the fund repays the loan, and the lender's recovery is generally limited to that asset. A recent change published by the ATO limits new arrangements over real property to business real property, so read that page and the SMSF property lending overview before planning one. Bare trusts are also used in some nominee and development arrangements, and lenders will want to identify the beneficial owner behind the trustee.

Why lenders ask directors for personal guarantees

Lenders give several reasons for asking the people behind a company or corporate trustee to sign personally:

• Recovery. Limited liability caps what the lender can recover from the entity itself.
• Alignment. People with personal exposure tend to keep the lender informed and act quickly when problems appear.
• Asset movement. A director's guarantee reduces the risk that value is moved out of the borrowing entity.

It is reasonable to ask whether liability can be capped, limited to this loan or released once the loan reduces. Each guarantor should get independent legal advice before signing.

Consumer law and business-purpose declarations

Loans to companies and corporate trustees generally sit outside consumer credit law. Where an individual borrows for a business purpose, lenders often ask for a business purpose declaration. A declaration may not remove protections if the lender knew, or should have known, that the money was really for personal use. Do not sign one that does not reflect the true purpose.

Tax and legal points to raise with your advisers

Privet cannot say which structure fits your situation. These are general questions worth putting to an accountant and a lawyer:

1. Will interest be deductible, given how the borrowed money will be used rather than what secures it?
2. Is a main residence capital gains exemption available, which is generally limited to individuals?
3. How will land tax apply to this entity in the relevant state, including any trust or foreign surcharges? See the stamp duty and land tax lesson.
4. Does the trust deed need wording about foreign beneficiaries to avoid surcharges in some states?
5. Will duty or capital gains tax arise if property is moved into a new structure later?
6. Do you need GST registration for a development or commercial property?
7. How would rules on loans between a private company and its shareholders affect money moving around the group?

A worked description in words

Imagine a hypothetical couple planning to buy a small commercial building through their existing family trust, which has a corporate trustee. The lender asks for the trust deed, finds a variation is missing and requests a lawyer's confirmation that the trustee can mortgage the property. It also asks both directors for a director's guarantee. Their accountant raises land tax treatment of trusts in that state before they exchange, so the purchase entity is settled before the contract is signed.

Common mistakes

• Signing a purchase contract in personal names and then asking to substitute a trust or company, which can create a second round of duty.
• Assuming a corporate trustee shields the directors from the loan, when a director's guarantee usually reverses that.
• Leaving the trust deed in a drawer for years, then discovering at settlement that a variation or change of trustee was never properly documented.
• Choosing a structure mainly because one lender prefers it, without checking the tax result with an accountant.

What to ask the lender

1. Which entity will be the borrower and which will hold title?
2. Who must sign a personal guarantee, and is it limited?
3. What trust or company documents do you need, and by when?
4. Is the loan regulated consumer credit for any borrower or guarantor?
5. Will you accept the trust deed as it stands, or will it need a variation before settlement?