What is Cross Collateralisation?
For many the world of finance and borrowing can seem complicated and confusing. Much of the terminology can be a little overwhelming and because of this many borrowers fail to learn some of the key principals they need to know in order to maximise their leverage and protect their assets fully.
One term often used which can lead to blank stares from investors is cross-collateralisation. In simple terms this is a lenders way of providing themselves with more protection. If Bank A is lending to you so you can buy Property A then that bank will want security on that property as a means of protecting themselves – they have an asset they can sell if anything goes wrong.
What if you own Property B and Property C as well and you have some equity in both these properties? For Bank A, extending the security across your other properties will provide them with a little more certainty. If Property A gets sold up and there aren’t sufficient funds to cover the remaining debt then they can sell Property B or Property C, or both, to cover the difference.
Lenders will instinctively seek the maximum amount of security they can, but this can be bad news for you as an investor as you are exposing yourself to losing more assets should anything go wrong.
Here’s some of the other disadvantages that cross collateralising your loans can have:
- A lack of choice when you sell up. If you are cross collateralised your lender will look at your risk in total, not property by property. Should you decide to sell a property at some point they may force you to repay some of your other loans to keep your loan to value ratio balanced across all your properties. You won’t be able to decide what you do with the proceeds from your own property
- Refinancing becomes tricky. It’s not hard to refinance an individual loan on a property but cross collateralising your loans makes the process of refinancing messy as you attempt to unravel the security on each debt.
- It’s harder to free up equity. Build up equity on an individual property and you can release this to help purchase another property. Build up equity in a cross collateralised property and you may find the lender reluctant to release that equity if other parts of your portfolio have reduced in value.
Protect your investments by avoiding cross collateralisation on your loans. There are ways of structuring your investment ownership and setting up your borrowings that can make it easier to do this. If you are looking to avoid cross collateralisation or need to refinance your way out of a messy debt structure over multiple properties, then talk to Ethan about the effective ways to reorganise your finances.