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Cross-Collateralisation
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Cross Collateralisation
Can I risk my house?
When investing in property, investors can employ what is called a cross-collateralisation loan. This 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
What are the issues associated with cross collateralisation?
1.Loss of flexibility
If a property portfolio is cross-collateralised it can severely limit 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 within a certain level. In that case, the loan proceeds would not be able to used at the investor’s discretion.
2.Increased complexity
Whenever one property in a cross-collateralised portfolio gets released, all of the properties in that portfolio need to be re-valued. This comes with significant costs as well as the need for extra documentation, such as Variation of Security. In that case, the loan proceeds would not be able to be used at the investor’s discretion.
3.Can be costly to change lenders
When involved in a cross-collateral loan, establishment fees are usually higher as there is an “additional” security charge. This cost can be compounded when an investor wishes to move those cross-collateralised properties from one lender to another In that case, the loan proceeds would not be able to be used at the investor’s discretion.
4.Equity access
If there is a rise in capital gain in one property but a fall in another, the net portfolio value may reach zero. This means the equity in the property that increased in the value is inaccessible to the investor because the overall equity in the portfolio. This is the main danger of cross-collateralising. Market downturns can be devastating and ultimately result in a situation where equity can’t be accessed.
5. Banks can get power over your home
If you can’t pay your home loan, the bank can decide where the proceeds of a sale are allocated on your cross-securitised mortgage. They can tell you what loan to pay, how much and when in order to keep the LVR within their acceptable level.
What do you need to qualify?
- The property securing the loan must be common to all loans under the cross-collateralised structure
- Each mortgagor under the cross-collateralised structure will be required to guarantee all loans within the cross-collateralised structure
- In the case of a third party loan where a borrower is not a mortgagor, that borrower must have a direct relationship to a mortgagor, with respect to control such as through a company structure, where a mortgagor is a director
- Stay within the bank’s mortgage exposure limits
Benefits
- Lower interest rates. Some lenders will allow you to use your owner occupied property and cross-securitise it with your investment properties.
- Greater tax benefits. You may be able to claim tax deductions on your investment properties because you’re using equity to purchase an investment property at 100% of the value, your purchase is potentially 100% tax deductible Compare this to getting a 90% investment loan when you’re missing out on these extra deductions because you partially secured the loan with your own funds
- Good strategy. when downsizing Many people buy an investment property with the intention of downsizing to it after selling their home. Having both properties under the same mortgage with the same lender makes it easier, especially if you don’t have big investment plans
- Unlock equity. Using a cross-collateralisation loan will help you unlock the equity you hold in your home or investment properties should you wish to grow your portfolio.
- Easier to manage. You may find it easier to manage your account and fees because you have one lender as opposed to if you were to take out two separate loans with different lenders
What is a loan to value ratio?
Loan to value ratio is how lender describe the amount you need to borrow to buy a particular property. Loan to value ratio is calculated by dividing the loan amount by the lender-assessed value of the property. Generally speaking, most lenders consider a LVR of 80% or more as being risky. Anymore then 80% and you will usually have to pay a Lenders Mortgage Insurance to protect the lender. In regards to cross-collateralisation, you can use properties to ensure that you keep the loan to value ratio below 80%. Problems can arise from this as banks can elect to sell properties intertwined in the loan to ensure that the loan to value ratio is kept below a certain level.
See below for an example of LVR:
Your home is worth $800,000 and you’ve paid off your mortgage, hence you have $800,000 in equity. You decide you want to buy a $400,000 investment property but you don’t have the cash for a 20% deposit. So you go to a lender and ask to use your home as the security for a $400,00 loan to buy the $400,000 investment property. If approved, this means that this one loan is secured by two properties worth a combined $1.2 million, putting the lender in a very safe position with an LVR of 33.33%.