This guide will show you exactly how a cross collateral mortgage works, and how cross-collateralization can hold back your property loans.
- The few benefits of it
- Massive risks to be aware of
- Issues caused when refinancing
And one example that saved one of our customers $5,352 in LMI.
So if you want to go from property rookie to property pro when it comes to cross-collateralization, this guide is for you.
Let’s get started.
- Cross Collateralization Fundamentals
- What is Cross Collateralization?
- Stand Alone Security or Cross Collateralized?
- Major Issues with Cross Collateralization
- What are some other things I need to keep in mind?
- How to minimise risk
Cross Collateralization Fundamentals
In this chapter, you’ll figure out the benefits and purpose behind cross-collateralization, and cross-collateralization loans.
These essentials include steps to qualify, the advantages, and common issues caused by cross-collateralization.
What is Cross Collateralization?
Cross collateralization is a finance term that is used when a loan is secured by two or more properties.
If you have a home and borrowed additional money for an investment property from the same bank they often cross collateralize or cross secure the properties to lend you additional money.
Benefits of Cross Collateralization
Cross collateralisation is usually most appealing for people who are trying to build their portfolio.
(And it appeals to banks, who get more security against your properties)
The typical buyer is someone who wants to hold onto their properties for a while.
And by that, we mean holding on to it for 10 to 15 years, and not looking to purchase any other properties.
When can cross collateralisation be used?
- ✅ Can be used when two properties are involved in securing a loan
- ✅ The equity from one property is used, for example, an owner-occupied property to purchase a second investment property.
Benefit 1: Get a lower interest rate
When you’re cross-collateralising, you can sometimes get a better interest rate.
Why? Because your properties are viewed as combined rather than each as an individual investment loan.
(And some banks see this as lower risk)
The savings can depend on the bank, the total lending amount and how much equity you have in your properties.
Benefit 2: Tax benefits
If your initial loan was owner-occupied, and your next property is an investment, you might be able to make a tax claim.
Also, if you’re using equity from it, then this is 100% tax-deductible.
Chat to your accountant about how your loan is structured and the tax benefits around it.
Benefit 3: Downsizing
If you plan on downsizing, then cross-securitising is for you.
By combining your mortgage with one lender, it makes your portfolio more simple to manage as there are less individual account splits.
Steps to qualify:
- ✅ You will need to stay within the mortgage limits
- ✅ If you use a guarantor, they will be required to guarantor all loans within the cross-collateralised structure
- ✅ Borrowers under this structure must be either a debtor or guarantor
Read More: How to use equity to buy a second property
What’s the difference with stand-alone security?
The concept of stand-alone security is that a loan is secured by just one property.
This method can also be used to build your property portfolio.
For example, you could use your family home as stand-alone security.
Stand-alone or cross collateralisation?
Generally speaking, stand-alone is recommended over cross collateralisation.
This is because cross collateralisation can become very difficult to ‘untangle’ the different properties, while stand-alone removes the unnecessary risk.
What happens with cross collateralisation is that if you had three properties ‘tied together’ but wanted to sell one of them, you would have to do the following:
- ⚠️ Value the other two properties
- ⚠️ Reassess the borrower’s financial position (which could come at a bad time financially)
- ⚠️ Require new mortgage documents to be issued.
Instead, if the properties are structured as stand-alone, the borrower could sell any property and pay it out with the loan that is secured by it.
The lender will not get involved in the current debt or other properties, like valuations and reassessments.
The Major Issues of Cross Collateralization
If you’re serious about cross collateralising your loan, then you need to understand the disadvantages and downfalls of it too.
The better you understand these, the more success you’ll have in working it in your favour.
So without further ado, let’s dive right in.
What are the drawbacks of cross collateralisation?
Cross collateralising has its drawbacks and risks; it can reduce flexibility and complicate your banking.
(In other words, you need to have all properties with the one bank)
So make sure you think twice before going ahead with it.
Your lender will highly recommend it, but make sure you speak with a mortgage broker to know all of the risks and limitations in line with setting up this structure.
Risk 1: Market downturns
The most significant risk is that all of your properties are connected.
So with one of your properties having a drop in value, this can affect your total portfolio.
Why? Because all your properties are linked.
The issue is that if the equity in one property has gone up, and the others have had a significant drop, then this will limit your overall equity from increasing.
So it’s kind of like a chain reaction.
Risk 2: Losing power over your loan
Again, because your properties are all linked, if you struggle to repay your home loan, then issues can arise with the bank.
In this situation, the bank will tell you what you pay and by when to keep the loan to value ratio in place.
Risk 3: With refinancing a loan, comes revaluing.
The problem with cross collateralisation is that when you want to refinance, every property needs to be revalued, not just one.
Due to this, the costs can be much more extensive, and banks will have to get a Variation of Security.
This process can be time-consuming and also puts risk around the bank coming back with lower valuation and stopping you from refinancing.
Risk 4: LMI costs WAYYYYY More
LMI is calculated on a sliding scale, and generally costs more the higher your loan amounts are.
So if you have cross collateralised loans, you could be paying thousands of dollars more.
Let’s look at a real-life example.
If you were buying a second property for $550,000 and were using equity from your original property of $300,000 you’d need to pay $20,096 in LMI costs.
Yep, that is a fair chunk of change.
However, if you went for a stand-alone structure you could save LITERALLY thousands.
What are some other things I need to keep in mind?
Alongside the risks, there are also other factors like lenders mortgage insurance or selling your property in the future to think of.
Lenders Mortgage Insurance
Unfortunately, the total lending is secured against all the properties.
If you want to borrow more than 80% of the value of one investment property, then lenders mortgage insurance will become applicable.
This is if there is isn’t enough overall equity in the properties.
The lender’s mortgage insurance premium is calculated on the total lending and could cost thousands of dollars.
Read More: LMI Calculator
Selling or Future Plans
When your loans are cross collateralised, and you decide to sell one, the bank will revalue the properties that will be held once the sale is completed.
They’ll decide and control the sale funds and can demand that the sales funds be used to pay down the debt. This can be frustrating, especially if you require the sales proceeds for other purposes.
Ease to Move
It may be costly to move your portfolio if your lender is no longer right for you.
For example, if you require additional funds and your lender declines, or they can no longer offer you competitive rates.
This restricting scenario can significantly affect your loan structure.
How to minimise risk
A great way to reduce risk around your loans with multiple properties is by working with at least two primary lenders. Often, buyers separate their loans home loans and investment loans splitting them up with different lenders.
By doing so, it helps spread your loans around so that if you get into financial trouble, it will work in your favour. While of course, it is easier just to have one lender taking care of everything.
But keep in mind the future and give yourself extra security to ensure you minimise risk.
How to know if a cross collateralised loan is right for you
Speak to Hunter Galloway about this in detail and get a free assessment with us today to find out about your personal situation.
What we do is make it simple to get through the home loan process, and with our team of experts, we will help walk you through the process to complete your first home buyers grant application. If you are buying or refinancing your home we can help walk you through the process.
Our service does not cost you anything as we are paid by the lender when your home loan settles.
To chat about your deposit, lending and investment lending options book in a time to sit down with us, or feel free to call on 1300 088 065.
The information on this page is general in nature and should not be considered as advice. Before you act on this information you must seek independent legal and financial advice.