Cross Collaterised Loans
What is meant by “Cross Collateralised” Loans?
Cross collateralisation denotes the practice of combining multiple properties into one larger source of collateral for mortgages obtained from the same lender. The most common setting for cross collateralisation occurs when a bank requires additional security for an existing or proposed loan.
The following is an example of how a typical cross collateralised loan works:
Suppose you currently have an outstanding $400,000 home loan with your bank. The mortgage is secured by your $800,000 primary residence. You locate an attractive investment property for $500,000. The initial outlay required for acquisition is $530,000. Borrowing against your home equity is an option. This would, however, entail a considerable stamp duty and other costs.
An alternative approach is a cross collateralised loan of $930,000. This would provide sufficient capital to acquire the investment property and retire your current home loan in full. Real estate values totalling $1,300,000 would secure a $930,000 loan. The loan-to-value (“LVR”) ratio of this loan proposal would be 71%. Any lender would find this figure very attractive.
By contrast, obtaining separate mortgages would yield the following results:
Loan 1: $530,000
$400,000 existing home loan and $130,000 required for investment property deposit.
As your $800,000 residence serves as the sole stand-alone collateral, the loan would have an LVR of 66%. From the lender’s perspective, this is even more attractive than the cross collateralized example cited above. It’s only part of the picture, however.
Loan 2: $400,000
This would be a new loan to finance the balance of the investment property’s purchase price.
As the investment real estate would be the sole standalone security for this loan, the LVR would be 80%. From a lender’s perspective, this is not nearly as attractive as the 66% of your separate refinance loan, or the 71% of a cross collateralised loan. Such an approach would likewise involve higher duty stamps and other costs, since two separate loans would be required.
Should I always choose a cross collateralised loan over a stand-alone mortgage?
The best answer to this question is highly-dependent upon several specific borrower-related and loan-related factors. In general, our recommendation is to avoid cross collateralised loans. The two main reasons for this position are the extreme difficulty of subsequent collateral severance and loss of borrower control over loans. Taken together, these two features of cross collateralised loan structuring create high risks for prospective borrowers.
By way of example, assume the following situation. You encumber 5 parcels of land with a cross collateralised loan. Subsequently, the need to sell one or more of the properties arises. As lien-holder of all the real estate, your lender may impose any of the following requirements:
1. Appraisal of the other 4 properties to ensure adequate residual security.
If the value of your remaining collateral portfolio is not enough to fully secure the outstanding loan balance, the lender may demand sale of all 5 properties. Based upon the relative value deficiency level, the mortgagee may even prevent the proposed sale altogether. For obvious reasons, this can be quite problematic for you. If the property you wish to sell is your portfolio’s “anchor” by virtue of having a much higher relative value than the others, you are probably out of luck.
2. Full re-evaluation of your economic status to establish continued loan affordability.
This can be very inconvenient for you. If, by the lender’s standards, your existing loan would be “unaffordable,” it can demand all proceeds from your proposed sale to reduce your total outstanding debt. If you are deemed to be in especially dire financial straits, the lender may demand immediate repayment of the whole outstanding balance – after retaining all proceeds from the prior sale. Such an eventuality would, of course, force liquidation of all properties within your collateral portfolio. In many cases, this includes the borrower’s primary residence. Refinancing via an alternative source may be impossible.
3. New documentation preparation.
Most banks and other mortgage financiers require the issuance and endorsement of two sets of entirely new loan documents. This is to be expected, as the composition of security for your current cross collateralized loan will be changed. This may seem a trivial matter in comparison to other potential consequences. Nevertheless, it is a source of considerable hassle and entails some expense.
With stand-alone mortgages, you may sell a parcel of land whenever you desire. Your only obligation to the bank or other lender is repayment of just one loan. There is no reassessment of borrower financial status, and no formal valuation of any other property you own. The most important advantage to you is full control over the disbursement of any sales proceeds.
Aren’t a lot of small loans much more cumbersome?
This concern is very common and valid. Consolidated debt with one lender certainly has many advantages over having multiple smaller balances outstanding with one or more lenders. A means of circumventing the major disadvantage of stand-alone loans is a revolving line of credit securitized by your most valuable realty holding. You may access it as needed for multiple investment purchase deposits.
Is a cross collateralised loan ever the best option?
There are instances in which cross collateralisation is the only practical loan structuring option. The most common instance is when none of your current realty holdings has enough equity to serve as security for a prospective investment purchase. The combined equities in two or more of your properties may be adequate to affect the purchase of a highly-desirable prospective investment acquisition. In such a case, you should definitely consider a cross collateralised loan, rather than miss out on potentially enormous investment gains.
What is meant by “all monies mortgages?”
“All monies” is used in the mortgage lending industry to denote a borrower’s entire outstanding debt with a particular lender. Many mortgages contain an “all monies” stipulation. Typically, such clauses allow your lender to accelerate all outstanding loans if you experience a material change of economic circumstances. Even your non-realty assets may be subject to forced liquidation. The only means of avoiding the attachment or involuntary sale of assets is to refinance your debt via a new loan or alternative lender.
Divide to minimize risk
For owners of multiple properties with several outstanding loans, we recommend the use of at least two primary lenders. If problems develop during the term of any loan(s), you already have a source of relatively easy refinancing installed. It is especially advisable to obtain a primary-residence home loan via one financing source, and all investment-related loans with another.
Learn more about cross collaterised loans.
