Cross Collateralisation is when a lender uses more than one property to secure a loan. What occurs often is when an investor purchases their first investment property and establishes one investment loan that is secured by their home and the new investment property.
I will now address the obvious benefits of such a method but also include its cons which often go unexplained.
It can be convenient for investors who only buy one investment property and do not need to alter their lending in the future. Secondly, lenders may offer interest rate discounts of one per cent with cross collateralisation for investors who borrow a large amount.
Another concern that my clients have had is that avoiding cross collateralisation might cost more in terms of establishment and ongoing fees because they need to establish more loan accounts. However, most banks offer packages that allow borrowers to establish separate loan accounts without paying extra fees.
Whatâ€™s wrong with cross collateralisation?
Extra costs: Can cost you on more valuation and variation fees than needed. If an investor who is already cross collateralised with three properties and wants to increase the limit on one of their loan accounts the Bank would have to order three valuations rather just one.
Limited choices: You may not be able to choose the best deal in the market because of having to accept current lenders non-competitive product offerings.
Less negotiating power: The Bank may assume that you canâ€™t be bothered refinancing because of the costs involved and therefore will not match the lowest fixed rate in the market.
Switching costs: Can be costly where fixed interest rate loans are involved with the cross collateralised properties. An investor can be ready to buy another investment property by utilising the equity in his home, yet his current lender will not lend him any more money due to serviceability. However, there may be other lenders who will come to the party. The investor could refinance yet incur huge break costs or would have to wait until the fixed rate expires.
Giving up too much security: A 5% deposit may be all thatâ€™s required from the equity on your home to then be able to purchase the investment property with 100% finance.
If you sell: If you sell one of your cross collateralised properties, the lender will have to consent to releasing its title but on condition that you use the entire of (part) sale proceeds to reduce other debt.
As you can see there are clear advantages and disadvantages with cross collateralisation. I suggest an in depth discussion with your mortgage manager to find out what works best for you.