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What all property investors should know about cross collateralisation

Cross-collateralisation is an important loan structuring issue of which many property investors are not aware.

Knowing the implications of cross-collateralisation is crucial to developing a long-term property investment portfolio.

So what is cross-collateralisation?

Cross-collateralisation occurs when more than one property is used to secure a loan or multiple loans.

For example, a person owns Property A and wants to purchase Property B without using any of their own funds.Сross-collateralisation Stratergy

The bank can use both properties as collateral for the new loan.

Many investors have cross-collateralised loans without knowing it.

One way to determine if loans are cross-collateralised or not (stand-alone) is by checking the detail in the loan contract.

There will be a section in the body of the contract which will note the addresses of the properties over which the lender holds or will register its mortgage.

Cross-collateralisation may often seem to be an appealing option to an investor, but it puts banks in a stronger position as it provides them with greater control over the properties.

There may be benefit initially to the investor in that he or she has not had to use their own cash to acquire the second property; however, this strategy does have the potential to negatively impact future investment opportunities.

There are several important issues to consider:

1. Loss of Flexibility

If a property portfolio is cross-collateralised it can limit severely the way in which sale proceeds may be used.

For example, if a property is sold, the bank might require that the sale proceeds are used to reduce other loans in that portfolio, to keep the Loan to Valuation Ratio (LVR) within a certain level.

In that case, the loan proceeds would not be able to be used at the investor’s discretion.

2. Increased Complexity 
investor-enquiry-form

It is often the case that every property in a cross-collateralised portfolio needs to be re-valued whenever one property is released.

There may be significant costs associated with valuing each property, especially if the portfolio is not within a loan package product.

The valuations are undertaken in order for the bank to determine its exposure with the remaining properties.

In addition, there is documentation to be executed every time a portfolio is changed.

This paperwork is known as a Variation of Security.

3. Limited Product Choice

In general, most property investors favour Interest Only loans.

As an investor’s exposure increases with any one lender, that lender can restrict future loans to only Principal and Interest.

Regardless of one’s asset position, many banks will want to control the type of loan that they will make available to an investor when his or her aggregate debt with them is high.

It can often be a better strategy for a smart investor to use multiple lenders and therefore gain access to the most suitable loan products.

4. Changing Lenders can be Difficult and Costly  Changing Lenders can be Difficult and Costly

When a loan(s) is secured by multiple properties, the establishment fees are usually higher as they include charges for ‘additional’ security.

This cost can be compounded when an investor wishes to move those cross-collateralised properties from one lender to another.

Exit fees can be significant, especially if any of the loans are fixed.

In addition, new valuations may be required (as explained above) where the investor wishes to release property.

5. Equity Access

If one property in the portfolio has enjoyed a capital gain and the others have dropped in value, the net effect on the total value may be zero.

The equity in the property that increased in value is inaccessible to the investor because overall the equity in the portfolio didn’t increase.

This can have serious consequences. For example, it could mean that an investor does not have ready access to cash and may miss valuable investment opportunities.

If the loans were not cross-collateralised, an application to increase the loan or credit limit against the property that increased in value would be a relatively simple process.

How can cross-collateralisation be avoided?Equity Access

Whenever possible, insist on stand-alone loans and securities.

Take out separate loans for each new property with the deposit and costs coming from an established line of credit or offset account.

Cross-collateralisation can be removed by the current lender, subject to LVR and product guidelines.

While I know a bit about finance and how it relates to property, you should always seek the opinion of a proficient finance broker who can provide assistance with refinancing or restructuring loans to avoid the potential shortcomings of cross-collateralisation.



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Michael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and his opinions are regularly featured in the media. Visit Metropole.com.au


'What all property investors should know about cross collateralisation' have 12 comments

  1. Avatar for Property Update

    July 15, 2016 @ 1:42 pm Alex

    Thanks Michael, this is exactly what my lender is suggesting. And I know what to answer and why.

    Reply

  2. Avatar for Property Update

    August 15, 2016 @ 1:15 am Susan

    Is not Cross-collateralisation better from tax perspective?

    Reply

    • Avatar for Property Update

      August 15, 2016 @ 7:17 am Michael Yardney

      Susan
      There is no tax benefit in cross collateralising a loan. A loan is tax deductible if it used for a business purpose or to create income

      Reply

  3. Avatar for Property Update

    September 29, 2016 @ 9:57 am tim

    If i do not cross collateral a loan for an investment property wont i have to use around $120000 20% deposit from equity in my own home? which will not be a tax advantage like borrowing the whole amount for the investment?

    Reply

    • Avatar for Property Update

      September 29, 2016 @ 11:07 am Michael Yardney

      Kim, there is a big difference between using your existing property as a security for a new purchase (so you don’t have to come up with a deposit) and having two separate loans in the process and the strategy we are suggesting you don’t employ – which is cross collateralise in those two loans

      Reply

  4. Avatar for Property Update

    January 16, 2017 @ 7:14 am nish

    Hi Michael, I really didnt understand the meaning of cross collateralisation. Do you mean here that one should not use the equity from one property to purchase another property. In that case how would one grow portfolio??? My finance broker is advising to use equity from my wife’s first property to fund my first IP.

    Thanks

    Reply

    • Avatar for Property Update

      January 17, 2017 @ 3:35 am Michael Yardney

      Nish. It’s common practice to use the equity from one property as the d deposit for the next one. But dont allow the bank to “cross collateralise” or link this equity release loan with your second loan, the one used to purchase the investment property.

      Reply

  5. Avatar for Property Update

    January 22, 2017 @ 12:57 pm Tony

    Very Good Article – will be bookmarking your site :) Cheers

    Reply

  6. Avatar for Property Update

    September 21, 2017 @ 7:39 pm shirley

    very interesting article, although too late for me now, we have just found out that our home is cross collatered with our investment property. we are just about to sell our home with the intention og buying ourselves another one to live in, and our broker says we will have difficulty because of this. feeling quite angry & confused now

    Reply

  7. Avatar for Property Update

    October 11, 2017 @ 4:37 pm Fran

    Hi Michael, We attended a free property seminar and it told us not to cross-collaterise our properties but it was discussed on a higher level. Thank you for a very detailed explanation. It is more clear now what the disadvantages are. However, I have a question for you. We do not have property yet and planning to acquire a land first – either 1 land that can be subdivided into 2 or 2 separate lands that are next to each other. So if we take out a loan in Bank #1, and leave the land for say a year, and take out the equity for the land to fund the building of our house to be our PPR then wait for it for maybe 2 or 3 yrs and get the equity of the entire Land#1 with House#1 to fund the building of House#2 in Land#2, can we have a different bank for loan for House#2? House# 2 will be rented out.

    This is if the land is 2 separate titles:
    Scenario 1:
    Bank#1 : Land#1 + Land#2 -> equity release -> House#1
    Bank#2: equity release from Land#1 + Land#2 -> House#2

    Scenario 2:
    Bank#1 : Land#1 -> equity release -> House#1
    Bank#2: Land#2 -> equity release -> House#2

    Reply

    • Avatar for Property Update

      October 11, 2017 @ 7:09 pm Michael Yardney

      Fran – I’m not very clear on your question but you can’t have 2 banks having loans over the one property

      Reply


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