Cross-collaterisation - the big word that can come with bigger risks
Cross-collaterisation, whereby you use one property as security for financing of the next property, can result in lower interest rates or increased borrowing capacity but also comes with great risks.
When it comes to building a property portfolio, the goal is to only need to save for the first property and build the portfolio from this starting block.
However, when you are financing for your next property, you may wonder whether cross-collaterisation will boost serviceability and allow for a higher loan amount.
For some investors, this may be the right financing strategy but for most investors cross-collaterisation is not a wise move and is likely to cause headaches down the track.
What is cross-collaterisation?
When you cross-collaterise, this means you are using one property as security for financing your next property.
If you decide to tap into your existing property’s equity and take out a second loan against that first property to fund the purchase of your next property, this is cross-collaterisation.
For some investors this might be the right option but for most, cross-collaterisation is something you should avoid. It is best to speak to your mortgage broker or lending professional about your best options for your individual circumstances.
For investors who cross-collaterise, it means they leverage their existing property for a simpler loan process, a better interest rate, and likely a higher loan amount. There may also be some tax benefits when you cross-collaterise your loans. However, it comes with some huge risks that should be considered before entering this type of arrangement.
What are the risks of cross-collaterisation?
The biggest risk with staying with the one lender for all your loans is that you may unintentionally cross-collateralise your properties due to the clauses on your second loan being easily overlooked, leaving you unaware of the cross-collaterisation or the multiple ways you are restricted.
You might even lose your property under this type of financing arrangement.
Another big risk to consider is that you will lose some control over your investment properties. Since all your properties are linked, when you sell one property the bank may take all the profits so you can maintain a particular loan to value ratio (LVR) on your loan.
Cross-collaterisation can also be messy and quite costly when it comes to selling your properties. Because the loans are crossed, all your properties will need to be revalued and this takes time as well as comes at a cost.
When investing in property it is wise to diversify your portfolio, so you will have different properties in different markets that perform differently, however, when properties are hedged against one another through cross-collaterisation you may lose any gains you have from a property that has performed poorly because the properties are linked.
This may also inhibit your ability to borrow more to move on to your next investment.
Ways to avoid cross-collaterisation
Diversifying your financing across multiple lenders is a great way to spread your finance risks and avoid cross-collaterisation.
If you stick with the same lender, some people find that they may have unintentionally cross-collaterised their assets without even realising, or without fully understanding what they were getting themselves into.
If you choose to take out a second loan with the same lender, it is important to be clear to your lender that you do not want to cross-collaterise your assets and have this in writing. Before signing any documents ensure you check this in the fine print and re-enforce that you do not want any cross-collaterisation between your assets.
Have a mortgage broker and solicitor review the loan conditions.
