Understanding the implications of cross-collateralisation is central to a long-term property investment strategy. With a cross-collateralised home loan, you can easily access your equity, but be aware of the complexity, product restrictions and costs.
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.
What is cross-collateralisation?
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.
Can cross-collateralisation benefit me?
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.
What are the pros and cons of cross-collateralisation?
Pros
- Access to equity. Cross-collateralisation allows you to access your equity, which you can use for other purposes such as a renovation or to purchase another property.
- Negotiation. If you have a higher total loan amount with a single lender, this can put you in a good position to negotiate more favourable loan terms such as an interest rate discount or lower ongoing fees.
- Manageable. When your loans are cross-collateralised, it can be easier to manage them. As you have one lender, it’s easier to keep an eye on your accounts and fees rather than having to constantly review your accounts with different lenders.
Cons
- Valuations. When an investment property is released, your portfolio needs to be revalued to help the lender identify its risk with the other investments. As a result, you’ll need to get your properties revalued, which can be time-consuming and costly. Each time a property is revalued, new documentation, such as mortgage documents, need to be provided.
- Less control. If your loan is cross-collateralised, it can mean that you lose control of your assets. If you decide to sell a property, the lender can decide the conditions of the sale and where the sale proceeds are directed. The lender may require you to use the profits from the sale to repay your existing loan.
- Product restrictions. Under a cross-collateralised structure, the lender can also restrict the type of loan that you can apply for. For instance, you may be required to take out a principal and interest loan. As investors generally opt for interest-only loans, this can be problematic.
- Difficult to refinance. It can be difficult to refinance to another lender due to the costs involved, such as high discharge fees or break fees for a fixed rate loan, which means you may not secure the most competitive interest rate. Even if you’re not getting the best customer service or the best available deal, you may be stuck with it. It’s also often very complex to change the cross-collateralisation structure.
- Costs. Generally, establishment fees are higher for home loans that are cross-collateralised and you may also need to pay lenders mortgage insurance (LMI) if you borrow more than 80% of the value of one property and there isn’t sufficient equity over all the properties.
- Too much security. Cross-collateralisation often results in the lender holding more security than is necessary for your loan. This means that the lender has all the power and it restricts your borrowing capabilities elsewhere.
- Maxing out. When you take out a cross-collateralised loan with one lender, you run the risk of reaching their maximum lending limit or their maximum exposure level. This means you won’t be able to borrow any more from the same lender if you need to in future.
- Putting your portfolio at risk. If you experience cash-flow problems and you’re unable to keep up with loan repayments, the lender has the right to take possession of any or all properties used to secure the mortgage. This means that cross-collateralisation puts your investment property portfolio at risk.
Bill's Cross-Collateralisation Problems
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.
What should I consider before cross-collateralising my loans?
- You may not be able to access property sale profit. If you sell an investment property that is cross-collateralised, the bank may request some or all of your sale proceeds to be used to help pay down the existing debt.
- Switching costs. When you have a cross-collateralised structure, it becomes difficult to refinance and switch to a new lender if you're no longer satisfied with your existing lender. You may need to pay expensive discharge fees, which can limit your refinancing options.
- Bank policy change. With cross-collateralised loans, you may find that you want to release equity but you can’t due to a change in the lender’s policy such as stricter lending criteria or lowered serviceability potential due to higher interest rates.
- Stamp duty. Another issue to consider is the different stamp duty costs and regulations that may apply when the properties on your cross-collateralised loan are located in different states or territories. In some cases, you may end up having to pay stamp duty on the entire loan amount (purchase property + security property), rather than only on the property’s purchase price. The mortgage document needs to be submitted and approved in the state in which you are buying the property, so if the security property is located in another state you may have extra stamp duty costs to the tune of several thousands of dollars to contend with.
- Cash-flow problems.If you develop cash-flow problems when paying off a cross-collateralised loan, your entire investment property portfolio is put at risk. So if the tenants move out of your investment property and you don’t immediately find new ones, you won't have any rental income to rely on and you may struggle to keep up with your loan repayments. As a result, the bank could sell the security properties in order to recoup its losses. With this in mind, diversifying your investment borrowing across different lenders can help you minimise risk.
- Don’t be fooled. Accessing the equity in your current property means you can take out an investment loan without physically handing over any money out of your own pocket, but don’t let this fool you into thinking you will be better off financially by cross-collateralising. It’s important to carefully consider the pros and cons before deciding on the right borrowing approach for you.
What is standalone security?
A standalone security means that your investment loan is secured by one property rather than several.
This can offer investors several benefits such as:
- Greater control. By maintaining your properties separately, you have more control and flexibility to decide when they are sold and how you will use the sale proceeds. Having more than one lender lets you take charge of your finances and manage loan repayments and sale proceeds as you wish, rather than being at the mercy of the lender.
- Less market risk. With a standalone structure, you can access equity as the property increases in value. The performance of one property does not impact the rest of your portfolio.
- No valuations. Under this structure, there is no need for the revaluation of your portfolio, which means you can save on expensive valuation charges.
How do I know if my loan is cross-collateralised?
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.
Do I have to refinance to restructure my cross-collateralised loans?
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.
How can I avoid cross-collateralisation?
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:
- Keep loans separate. Apply for individual home loans for each new property and ensure that the associated costs are coming from a separate account such as an offset account.
- Request for its removal. If you discover that your loans are cross-collateralised and you would like to change the structure, this can be done by the lender upon request.
How can I protect myself?
Here are some ways you can overcome the inherent risks of cross-collateralisation:
- Apply with more than one lender. Consider applying for investment loans with at least two different lenders to give you greater product choice and control.
- Limit borrowing amount. Try not to borrow more than $1.5 million per lender. This means that you can benefit from interest rate discounts and remain within the lending approval limits imposed by credit authorities.
- Seek advice from a mortgage broker. Mortgage brokers are home loan experts and can help you find the right loan for your needs. They can also help you understand all the benefits and risks of cross-collateralisation, so find a mortgage broker with an in-depth understanding of investing in property to get advice tailored to your needs.
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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