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When you take out a home loan to purchase an investment property, the lender will generally use the property as security for the loan. Typically, one property is used as collateral for one loan. As you diversify your property portfolio, you can keep each property and loan separate or you can choose to cross-collateralise the properties.
Cross-collateralisation, which is also referred to as cross-securitisation, is where the lender requires the borrower to use more than one property to secure the loan. For example, your investment home loan might be secured by your investment property and your primary place of residence.
In some cases, cross-collateralisation can be a useful vehicle for investors, as it can allow you to access credit easily. However, this is only a suitable strategy where there are two or more properties involved and where the investor is fully aware of the inherent risks.
By definition, collateral is security that is used for the payment of finance. Therefore, cross-collateralisation involves using more than one property as security for one or multiple loans with the same lender. If your home loans are under a cross-collateralised structure, this means that the lender is securing your total and combined loan amount with your securities.
As an investor, you may benefit from cross-collateralisation in the sense that you can use equity in one property as a deposit for another investment property and thus diversify your portfolio. It also means you have fewer account-keeping fees, as you won’t have separate loans for each property.
However, cross-collateralisation is a borrowing approach that will only work in certain situations. For example, if you have a default on your credit file and need to access finance from a lender that specialises in non-conforming borrowers, you will typically have high-interest rates and fees on the loan. By offering a second property as security on the loan, however, you may be able to lower the loan to valuation ratio (LVR) and take advantage of a lower interest rate and reduced fees.
Keep in mind that there are some drawbacks to cross-collateralisation, especially with regards to the amount of control that you have over the sale and sale proceeds of your assets. Cross-collateralisation can be risky during the initial stages of holding a new investment property when you have minimal equity, while if you fall behind on your loan repayments the lender can take possession of any properties secured on the mortgage. That’s why many investors may be better off taking out an investment loan with a standalone security.
It’s worth pointing out that when you cross-collateralise, the bank often ends up holding much more security than is necessary. For example, if you want to use Property A worth $700,000 to buy Property B for $300,000, the bank ends up holding $1 million worth of assets against $300,000 worth of loans.
Bill is 52 years old, retired and owns three investment properties. He lives off the rental income from those three properties, which means he does not qualify for the age pension.
Thanks to a cross-collateralisation arrangement, Bill has borrowed money to purchase each property with the same bank. Initially, Bill has been making interest-only repayments on loans for his investment properties, but as the interest-only period comes to an end, Bill asks for it to be renewed.
However, his bank has other ideas. As Bill is no longer working, the lender views him as a higher-risk borrower, so they insist that he switches over to principal and interest payments to start paying down his debt. While his rental income should cover his increased loan repayments, Bill knows he needs some extra money to live on and decides to sell one of his investment properties, an apartment valued at $300,000.
But Bill’s bank will only release the mortgage on that apartment if he uses the sale proceeds to pay down the loans on his other two investment properties. This leaves Bill with two undesirable choices: sell a second property or go back to work to generate the income to cover his living expenses. In the end, Bill is forced to come out of retirement and return to work — something which would not have happened if he had kept his loans separate rather than cross-collateralising.
A standalone security means that your investment loan is secured by one property rather than several.
This can offer investors several benefits such as:
Many investors think that their investment loans are standalone when they are actually cross-collateralised. It is common for lenders to cross-collateralise your mortgage even without your consent.
The easiest way to see if your loan is cross-collateralised is to check your home loan contract. It should include a section that specifies the addresses of the property in which the bank holds the loan. If more than one property is listed under ‘security’, then your loan is cross-collateralised.
No, you don’t necessarily have to refinance with a new lender to restructure cross-collateralisation. Instead, you can restructure your loans by speaking with your existing lender (in order to save on switching costs).
If in doubt, always consult a licensed mortgage broker to help you understand your options and how you should structure your loans.
Advise your mortgage broker or lender that you’re only interested in standalone home loans (if you believe this is the right strategy for you).
As cross-collateralisation can be risky for investors, here are some ways to avoid it:
Here are some ways you can overcome the inherent risks of cross-collateralisation:
Cross-collateralisation can help you access equity and diversify your portfolio, but it can also be a risky and unsustainable strategy for investors. It pays to speak to a lender and mortgage broker to find the best home loan structure for you.
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