Property 101: Cross-collateral loans

GUEST OBSERVER

The Macquarie dictionary explains collateral as, “Security pledged for the payment of a loan” and to cross-collateralise is to pledge multiple securities for the payment of a loan or loans.

An Example :

1. Property A is owned by Person A

2. Person A wishes to buy Property B but has no money for deposit.

3. Person A buys Property B with 100 percent loan and the Bank holds Property A and Property B as security against loan for Property B. Property A & B are said to be cross-collateralised.

In 95 percent of cases cross-collateralising is not beneficial to the borrower, it favours the bank, cross-collateralisation isn’t a problem until it becomes a problem, and then untangling it can be a long, expensive and traumatising experience. People loose fortunes both in real time, money and opportunities as a result of cross-collateralised structures.

Ten disadvantages of Cross-Collateralising your property portfolio…

#1. When you sell a property in a cross-collateralised structure you may not see any of the funds as the bank may request some or all of it to go back in against the existing loans to strengthen their position. They don’t need your permission either. Picture this you’re releasing one of your properties for an opportunity or worse still a bind, and the bank deducts funds to strengthen their position. Where would that leave you? I have seen this happen to some very asset strong and successful property investors. Answer given, Bank Policy!

#2. When you sell a property you have to resign all of the existing mortgages. Extra unnecessary paperwork.

#3. You can loose product selection and control by being with just the one bank. For example the bank can say no more interest only loans for you, we want you to take a Principle and Interest loan from now on, to reduce your debt with us. This is quite common when your borrowing levels get up with the one funder. 

#4. Bank holds far more security than often necessary, for example Property A worth $800 000 is used to buy property B for $250000. The bank has $1 050 000 of assets against $250k of loans. The result is that the bank holds all of your cards.

#5. Buying across state boarders you are subject to mortgage document stamp duty of that state, this in itself is OK, but when you have other properties as security for the purchase, regardless of the state they are in you may have to pay the mortgage document stamp duty on the entire loan amount, rather than just on your purchase price. For example, purchase property A worth $300,000 in QLD but for whatever reason you have offered another property as security and it is worth $500,000 in the ACT, you would have to pay mortgage document stamp duty on the whole portfolio of $800,000 and this is because the entire mortgage document has to be stamped in QLD.

This duty is a state duty and is different in every state or territory. An example of the difference in the amount payable can be, where the stamp duty is $4 in a thousand, for the cross-collateralised mortgage document stamp duty you are up for approximately $3,200, but if you had your purchase as a ‘stand alone’ loan you will have to pay approximately $1,200 . If you need to find out more about this point, please give us a call.

#6. Having at least two lenders gives you the flexibility of playing one off against the other, giving you more choice an ultimately more control.

#7. If you want to realise some increased equity when properties have grown in value you need to have your whole portfolio revalued (multiple valuations instead of one, again an additional and unnecessary cost).

#8. You can run out of borrowing capacity with one lender when you reach their maximum serviceability / exposure levels.

#9. It is so much harder to move banks, if you no longer like or agree with their service or lack of. 

#10. If you have cashflow problems, your whole portfolio is at risk. Better risk management from your respect is to not cross.

There are numerous more reasons why not to cross-collateralise, especially if you have a business with Overdrafts / partners / Fixed and Floating Charges etc, there are also simple ways to combat the banks having too much security with financial instruments like Deposits under Lien and secondary funders. An experienced Mortgage/Finance broker can help you with structuring advice specific to your own needs, and keep you in control of your assets.

Peter Tersteeg is mortgage broker, Sage Lending Solutions and can be contacted here.