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What is a Cross-Collateral Loan and why should investors avoid it?

Many property investors get stuck after their first two or three properties due to cross-collateralisation. Their properties have done incredibly well, with great location and property selection. But what they’ve forgotten is that a lending strategy is just as important as where to buy. 

What is cross-collateralisation in real estate?

For those new to property investment, you may be asking, “how does cross-collateralisation work?”

When building a property portfolio, ‘cross-collateralisation’ or ‘cross-securitisation’ is where you buy one property and the bank says that it now is collateral to buy the second property. This means that if anything happens to the second property, they have first access rights to your first property.

Whether that first property is an investment property and you’re buying a second investment property, or that first property is a principal place of residence, and you’re buying your first investment property, you don’t want to be cross-collateralised. You want each of those loans to be completely individual and separate. 

It’s important to remember that just because you’ve got multiple mortgages with the same bank it doesn’t necessarily mean you’ve cross-securitised. Cross-securitisation/collateralisation is a specific strategy that you organise with the bank. We understand that more than one loan with the same bank is necessary to build a property portfolio. But make sure you aren’t organising a cross-collateralisation loan. 

To explain further, let’s look at five limitations of cross-collateralisation, using some cross-collateralisation examples.

1) Loss of Flexibility

Let’s say you have two properties, with the second being cross-securised to the first property (in other words, the bank has given you the loan holding the first property as security). If you sell property #2, you must pay off part of property #1.

Perhaps you intended to use the funds generated from the sale for some other reason besides paying off the first loan. But now, because the properties were cross-securised, money has to be put towards the first property. A cross-collateralisation loan essentially restricts what you can do with the money, ultimately sacrificing flexibility. 

2) Increase Cost and Complexity

When looking to buy an additional property, you may need to have one of your current properties revalued. This will help determine whether you have enough equity to buy that additional property. But because you have these other properties tied up with a cross-collaterisation loan, the bank will want to revalue all properties.

Instead of just revaluing the property that has risen, they will want to assess and revalue your whole portfolio. This will increase complexity, cost and take a bit longer than you might like. We want to be nimble in property investment, especially in this growing market. 

3) Limited Product Choice

If you are with the same bank and you have two, three, or four loans that are all cross-collateralised, the bank will at some point deny you further loans unless they are a principle and interest loan. You may be an investor that wants an interest-only loan, but because you are cross-collateralised and all tied up with this specific bank, they are in the position to deny the interest-only loan.

But if you weren’t cross-collateralised, then you have the option of going with another bank, or some other alternative lending option, granting greater flexibility and product choice.

4) Changing lenders can be difficult and costly

Let’s say you have two or three properties that are all cross-collateralised, but you want to call it a day with that specific bank. But because of these two or three cross-collaterisation loans, you are all tied up with this bank. There will often be a range of exit fees, as well as confusing and complex paperwork that costs you time and money. These exit procedures are never as straightforward as expected. 

5) Equity Access

The most prominent way property investors generate wealth is when the property goes up, using the equity for the second property deposit. Then, it’s about waiting for that second property to rise, using the equity for the third deposit, and so on.

When it comes to cross-collateralisation, the banks are in the best position to view your whole portfolio. They can see that even though property #1 has gone up, perhaps property #2 and #3 haven’t. They are then able to deny releasing equity from property #1.

If you weren’t cross-collateralised (and even with the same bank), if just property #1 goes up, they would most likely give you the funds to buy another property. But if you’ve cross-collateralised, then there will be hesitation to provide you with more equity for a fourth property because some properties haven’t risen. Ultimately, exposing your portfolio to the bank can be a bad idea, as it limits your options. 

We hope we’ve answered ‘what is a cross-collateral loan?’ and given you a bit of an understanding of why it might be limiting for a property investor. Still, have questions about a cross-collateralisation loan strategy? Get in contact today!

PK Gupta
Published: 11 Jan 2022


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