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To cross collateralise or not?

Marty McDonald - Wednesday, April 13, 2011

Last week I posted about how to gain access to your properties equity to assist with investing. That lead to the topic discussed here of how best to structure your loans when accessing equity.


As a recap there are two loan structuring methods that can be used to access equity; the stand alone security method and the cross collateralisation method. The stand alone security method means that loan(s) are secured solely by one property while cross collateralisation means loan(s) are secured by the equity in two or more properties.

As an example say you owned your home outright and you wanted to purchase an investment property of similar value to your home and you wanted to borrow the entire purchase price and associated costs such as stamp duty.

Cross collateralisation method

Using this method you would put your home up as security in addition to the new property and borrow the entire purchase price plus the associates purchase costs. Because you have lots of equity in your home the lender is comfortable with the overall debt to equity ratio or loan to value ratio (LVR) across both properties. Assuming both properties are worth around the same amount the LVR would be a little over 50%.

Stand alone method

You could structure the loans as stand alone by doing the following. Apply for a loan to the value of 80% against the new investment property (that way avoiding unnecessary mortgage insurance costs) secured solely by the new investment property.

Apply for a second loan secured solely by your home for the other 20% required for the purchase and additional funds for the associated costs such as stamp duty. Usually say 25% of the purchase price would be enough.

So which is better Stand Alone of Cross Coll?

I always recommend stand alone if it's practical...The reasons are:

Makes it easier to change things:
If you sell or refinance a property and the loans secured by that property are independent of your other loans and properties it means no re-work by the lender is required. No updated valuations are required. No reassessment is required of your ability to service the remaining loans. So in summary its easier to make changes to your loans and properties.

Control of sale proceeds:
As the loans and properties are independent from each other using the stand alone method this means when you do sell a property you can dictate what happens to the sale proceeds. If the properties are tied together via cross collateralisation the lender can require you to reduce your other loans to an acceptable LVR which means they control the process of what happens to your sale proceeds!

You can change lenders more readily:
If you have multiple properties all crossed together you are effectively at the mercy of your lender and their valuations. This can and often does impede investors from reaching their investment goals. One change to a lenders policy and you may be stuck with your lender or face refinancing your entire portfolio which may not be possible. The changes to lo doc lending policies is  an example of this in the recent past. With stand alone securities their is always more options available such as spreading your loans amongst two or three lenders to continue on with your investing goals.

Risk mitigation:
In a falling property market your overall portfolio of properties may drag you down. If you ever got into financial trouble and needed to sell a property to access some cash this could be problematic if you are reasonable highly geared and the market had dropped. As all your properties are bundled together the lender could decide to revalue all your properties as part of the reassessment / partial discharge process. Valuers in a down market are notoriously conservative which would exacerbate the problem. The end result could be the lender requires the entire sale proceeds to be paid into your remaining loans leaving you none of intended sale proceeds. In a worst case scenario a lender may even decide that they wanted all their loans repaid, essentially the equivalent of a margin loan / margin call. While I have never seen this happen it is not beyond a lenders powers if your loans are set up this way. If you were structured in a stand alone fashion you would have much better control of your situation.

So why would anyone cross collateralise?

There are three main reasons:

Firstly bad advice from your mortgage broker or bank manager!

Secondly your lender prefers you are crossed and will default to this position unless you tell them otherwise. It is not uncommon for them to try and do it anyway without telling you even if you request they do not do so! The reasons they want you crossed up is its better security wise for them and it makes it harder for you to leave .

Thirdly sometimes it is just not practical to do the stand alone method as you end up with too many small loans. A strategy I used recently with a long time client was to cross two of their properties (they had three and were buying another). That way we were able to secure a line of credit against the two properties that was sufficient to cover the deposit on the new purchase and left enough available redraw for future investment property deposits. If I had in this instance just chosen one property for the line of credit it is likely we would have also have had to do another small loan against one of their other properties in the very near future. So in this instance it made sense to cross collateralise. That said I would recommend never crossing more than 2 properties as the complications in untangling them and risks outlined above just don't make it worth it in my humble opinion.

Other pages on the Mortgage Experts site you find interesting:

Loan structuring advice investors

Current mortgage rates


Regards,


Marty McDonald

About the Author: Marty McDonald is principal of mortgage broker “Mortgage Experts”. Marty specialises in assisting active property investors with loan structuring advice and implementation as well as helping credit worthy borrowers with slightly outside the box income and employment situations. Find Marty on and LinkedIn.

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