Cross collateralisation - 10 reasons to avoid

The Macquarie dictionary explains collateral as, “Security pledged for the payment of a loan” and to cross-collateralise is to pledge multiple securities for the payment of a loan or loans.

An Example :
1. Property A is owned by Person A
2. Person A wishes to buy Property B but has no money for deposit.
3. Person A buys Property B with 100% loan and the Bank holds Property A and Property B as security against loan for Property B. Property A & B are said to be cross-collateralised.

In 95% of cases cross-collateralising is not beneficial to the borrower, it favours the bank, cross-collateralisation isn’t a problem until it becomes a problem, and then untangling it can be a long, expensive and traumatising experience. People loose fortunes both in real time, money and opportunities as a result of cross-collateralised structures.


Ten disadvantages of Cross-Collateralising your property portfolio…

#1. When you sell a property in a cross-collateralised structure you may not see any of the funds as the bank may request some or all of it to go back in against the existing loans to strengthen their position. They don’t need your permission either. Picture this you’re releasing one of your properties for an opportunity or worse still a bind, and the bank deducts funds to strengthen their position. Where would that leave you? I have seen this happen to some very asset strong and successful property investors. Answer given, Bank Policy!

#2. When you sell a property you have to resign all of the existing mortgages. Extra unnecessary paperwork.

#3. You can loose product selection and control by being with just the one bank. For example the bank can say no more interest only loans for you, we want you to take a Principle and Interest loan from now on, to reduce your debt with us. This is quite common when your borrowing levels get up with the one funder.

#4. Bank holds far more security than often necessary, for example Property A worth $800 000 is used to buy property B for $250000. The bank has $1 050 000 of assets against $250k of loans. The result is that the bank holds all of your cards.

#5. Buying across state boarders you are subject to mortgage document stamp duty of that state, this in itself is OK, but when you have other properties as security for the purchase, regardless of the state they are in you may have to pay the mortgage document stamp duty on the entire loan amount, rather than just on your purchase price. For example, purchase property A worth $300,000 in QLD but for whatever reason you have offered another property as security and it is worth $500,000 in the ACT, you would have to pay mortgage document stamp duty on the whole portfolio of $800,000 and this is because the entire mortgage document has to be stamped in QLD. This duty is a state duty and is different in every state or territory. An example of the difference in the amount payable can be, where the stamp duty is $4 in a thousand, for the cross-collateralised mortgage document stamp duty you are up for approximately $3,200, but if you had your purchase as a ‘stand alone’ loan you will have to pay approximately $1,200 . If you need to find out more about this point, please give us a call.

#6. Having at least two lenders gives you the flexibility of playing one off against the other, giving you more choice an ultimately more control.

#7. If you want to realise some increased equity when properties have grown in value you need to have your whole portfolio revalued (multiple valuations instead of one, again an additional and unnecessary cost).

#8. You can run out of borrowing capacity with one lender when you reach their maximum serviceability / exposure levels.

#9. It is so much harder to move banks, if you no longer like or agree with their service or lack of.

#10. If you have cashflow problems, your whole portfolio is at risk. Better risk management from your respect is to not cross.


There are numerous more reasons why not to cross-collateralise, especially if you have a business with Overdrafts / partners / Fixed and Floating Charges etc, there are also simple ways to combat the banks having too much security with financial instruments like Deposits under Lien and secondary funders. An experienced Mortgage/Finance broker can help you with structuring advice specific to your own needs, and keep you in control of your assets.

 

Great post Pete
Think I did something wrong above

 

Awesome thread thanks Peter for the information

 

Peter you missed the most obvious one. If you cannot pay your loan the mortgagee can take possession of either or both properties secured by the mortgage.

At least when you have 2 properties with 2 banks they must first go through a long court process. This will give you time to sell on your own terms and allow you to apply the funds left over from the sale as you please.

 

Very good PT

 

Great post Peter, thanks for sharing.

 

I certainly agree Terry, crossing loans and securities gives lender access to more than just one house. Point 10 does suggest what you're saying.

However whilst this tends to be the thing that people fear the most, in practice, this is probably one of the least likely end results of cross collateralisation; lenders aren't fundamentally interested in repossessing houses. Problems with selling a single property, getting access to equity or sales proceeds, being boxed into a single lender. These are the problems we see all the time, but it's not what people anticipate with cross collateralisation.

 

I think this is a MUST sticky post! In my 1 year on SS I heard questions asked about X-Coll weekly! This is critical information for any investor and should be made readily available.

Great post Peter and so happy to see you, Terry, Paul, Redom, Mick, Tobe, Jamie and all the other amazing brokers and accountants on the new forum. Many more years of structuring questions coming your way

 

Sorry - yes it does

 

Here are 2 real life examples of banks dictating your retirement when crossing.

Case Study 1.
Elderly woman owning about 4 properties, living on rents not qualifying for the pension. Slowly loans reverted to PI from IO after the initial 5 year term. Asked bank to renew the IO term, but they refused saying she had no job so they wanted the debt paid down to reduce their risk. Cash crunch kicking in she decided she had to sell just 1 property to release some cash to use to live on, supplemented by the rents.

Guess what the bank said? When you sell we will only release the mortgage if you use the proceeds to pay down the remaining loans on the other 3 properties. So now she had only 2 choices - 1 get a job, or 2 sell a second property, or maybe a 3rd and end up with just 1 property fully paid off - no leverage.

Case Study 2
younger guy had a large portfolio of property, all slightly negative geared but he had retired with the plan of selling one property every few years and living off the proceeds until the rents increased enough so he could live on the rents solely. he had quit his job and was happily in retirement until the bank said the same thing as case study 1. Not working we will therefore use the proceeds to pay down the loans. That can ruin your retirement.

Learning from these mistakes:
1. Never cross and
2. Extend your IO periods as long as possible just before you quit your job to retire - and
3. While you are at it increase your loan term as well.

 

Very insightful... Thanks for the list!

 

Wow. Now I understand what someone was trying to explain a few days ago. It all makes sense now. thanks

 

Question if you have Property A & you refinance to say 80% LVR, then use that cash to make the deposit & costs for Property B, is that still considered as cross coll? On paperwork you aren't listing Prop A as security for Prop B right.... .even if using the same bank...

 

Cross collateralising is when you use 2 securites for 1 loan.

So in your example, JMica, it will be possible to do it without crossing. 1 loan 1 property.

 

Thanks Terry, so why wouldn't people just refinance and use the cash instead of using both properties as security?

 

I guess it is because they don't know what they don't know and the banks prefer to maximise their own benefits at the expense of borrowers.

 

True true, sometimes I think of these things and think maybe I'm just missing something....

 

I totally agree - LVR & DSR.

Being able to Build a substantial size residential property portfolio is not about 'property'.

Its about finance and structuring it in such a way so as to be in a position of being able to continually accessing it to keep purchasing and building your portfolio.

You must meet the banks/lender LVR & DSR lending modules and place yourself in a position to do so 'before' hitting their module walls because if you leave it until after its too late - catch 22.

You need to get an IP savy mortgage broker on your team, sit down with them and discuss 'your' big picture goals & proposed investment strategy for attaining those goals before anything else.

I hope this helps.

 

The reason why people got suck into these kind of loan structure is because they thought by doing a cross-collateral loan they don't need to fork out any physical cash, this is exactly what my colleague told me when she wants to buy an investment property. I told her not to do it and list out all the negative stuffs and she end up not doing this loan structure plus not buying lol, it is the mindset of people that feel like they have to fork out money as well as increasing their existing loan, it doesn't make any sense when you type it out but people just don't see it when they are scared and I suppose stingy lol

Another reason why is because some banks will want you to hold a larger loan account with them so they can fulfil your lower rate needs, banks have a system to calculate if each loan product are profitable enough to offer a lower rate, if the system said 4.99% is the best rate they can do base on your borrowings and any sort of attachments with the bank they will not go lower no matter how many complains you lodge.