Cross Collaterisation – what is it and who does it benefit the most?
Do you know what Cross Collaterisation is? If you have multiple properties and all loans are with setup by one single lender then chances are, your loans may be cross collaterized.
When you purchase a property, you usually would chip is 20% of deposit and borrow 80% as mortgage which is secured against the property you’re purchasing. So in this scenario the single mortgage is secured against single property.
Cross collaterisation (I will be abbreviating this term as X-coll for rest of this article) is a term that describes loan(s) which are secured against multiple properties. So in essence they are using two (or multiple!) properties as collateral for your loan.
Continuing on from last scenario – if you have an existing property and want to purchase another property with the same lender, they may suggest that you don’t need to pay any deposit – sounds too good to be true right?
Well like a lot of things in life – if it’s too good to be true then it probably is.
What they are doing here is essentially take the equity from property 1 and use it to “fund” as the deposit for property 2 – but without first taking the equity out as a separate loan. Therefore what will happen is that both property 1 & property 2 will be noted as the security used to obtain the loan for security 2. It’s all lumped together.
X-coll is messy and can seriously hinder the abillity for an investor to grow their portfolio for a couple of reasons:
- Value is sensitive to market downturns
Because of the fact all properties are linked, the capital growth of one property could be negated by drop of another. Which means even if you want to take equity out from the portfolio you would not be able to do – as the growth of one property cancels out with the other one!
- All properties need to be valued at time of refinancing
Let’s say you’ve realized you made a mistake by letting bank taking control of your finance and now want to refinance out to take control back – well, you would want to pray that the valuation of all properties come back decent. Because if the total value doesn’t stack up, you may have to pay LMI in order to refinance or even worse, LVR exceeds what the new lender is willing to accept and therefore cannot refinance out.
In addition there are significant costs associated with multiple valuations – so you may end up paying a whole heap of fee without able to refinance due to various things could go wrong as part of decluttering process.
- Banks have full control of your properties & loans
Even worse, if you default or have trouble making/affording repayments, then banks have the ability to dictate which property to sell and what debt to be cleared. Note it’s the bank that have power to do this, not you.
If you have also X-coll your own home, then you would hope they would not ask you to sell your home before your IPs. As you do not have any control, you could end up being forced to get out of your own home!
So hopefully this example demonstrates some idea on how X-coll benefits banks but not you as the end consumer. The worst part is that banks will not tell you that your properties are X-coll’d during setup of the loan – and why would they? They obviously want to ensure they have maximum control in order to benefit them when the time comes.
Hopefully by now you understand the implications of X-coll. So how can you avoid getting yourself into a X-coll situation? There are a couple of ways:
- See a MFAA & qualified Mortgage Broker to ensure your loan structure is setup correctly based on purpose and your goals – each loan should only be secured against single property, not multiple properties!
- Banks will try sell you into X-coll situation by advertising that you can get the same low interest rate for both the investment property & your own home. While it sounds attractive, would you trade that small difference of about 0.4% or 0.5% to allow banks to take FULL CONTROL of your home plus IPs and lock you in? So be extra cautious when banks try sell you the same low rate for investment property as your own home.
- When signing loan contract check how many security is noted on the loan contract? It should be only one at all times. If you see multiple properties/addresses listed there, chances are banks are getting you into a X-coll situation.
If you suspect you are currently in a X-coll situation with your current lender, feel free to contact us for a free review of your current finance situation and see how we can help you take the control back!