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What Is Cross Collateralisation?

Cross Collateralistation is linking finance for two or more properties together. What happens to one property financially impacts the other property, in particular in an event of a sale. Avoiding cross collateralisation is a good risk mitigation strategy.

Ryan and Meg own two properties. When they came to buying an investment property, the bank cross collateralised the two properties, such that they only had to borrow $250,000 for the new property and $250,000 came from the PPOR

Principal Place of residence (PPOR) Value = $ 1,000,000

Principal Place of residence (PPOR) Loan = $ 750,000

Investment Property Value = $500,000

Investment Property Borrowing = $250,000

This means a number of risks for Ryan and Meg when it comes to sale, re-finance / equity draw down, future borrowings, concentration risk and the high costs associated with untangling the cross collateralisation

What Are The Risks With Cross Collateralisation?

  1. SALE OF A CROSSED PROPERTY

Crossing properties gives the lenders the ability to pull or retain funds from one property for the other in case of sale. That is, if one property is sold, the other property will be reviewed by the bank before the sale is allowed to be completed. In extreme cases the banks reserve the right to decline the sale of a property due to the cross collateralisation

  1. RE-FINANCE / ACCESSING EQUTIY WHEN VALUES INCREASE OR DECREASE ACROSS THE SECURITIES

Extracting equity from one property requires the entire portfolio to be revalued by the bank, which means if some properties have dropped in value and yet others have grown and the net gain is zero, the lender may not allow equity extraction. This has the implication of the investor not being able to expand their real estate portfolio or pull equity for risk mitigation or for exploring other opportunities.

  1. CHANGE IN LENDER POLICY IMPACTING FUTURE BORROWING

Should the lender appetite change for example, tightening of servicing calculators which has become prevalent with the recent APRA speed limits on the lenders, the investors may struggle to re-finance to a different lender for further borrowing, especially where the finance structuring of the over all portfolio is not aligned to the investor goals

  1. NO SCOPE FOR VALUATION SHOPPING

Lender A may value the property at $x while lender B may value it at $x+1. Uncrossing the properties by restructuring the finances is a lengthy process with risks involved such as low valuation, servicing limits with the given lender etc. Therefore the investor will not be able to take advantage of valuation shopping without full applications and assessment of all lending across the crossed properties. If even one of the crossed properties is left with the original lender due to low valuations, the outgoing lender may want to value ALL properties before releasing any of the securities. This may also lead to a failed attempt at re-financing to uncross the properties due to the valuations falling short

  1. CONCENTRATION RISK

Defaulting on one property risks the bank selling both of your properties

  1. COSTLY & TIME CONSUMING TO UNTANGLE THE CROSSING

Multiple properties across various lenders may mean multiple establishment costs due to multiple securities. The exit fees will also be high when multiple properties are re-financed to uncross the securities

How To Un-Cross Collateralise?

Ryan and Meg can speak with their broker to un-cross the properties by…

  1. Looking at servicing calculations with suitable lenders to see whether all properties can be re-financed (pending valuation)
  2. Ordering upfront valuations for the crossed properties and applying for a re-finance within the same lender or to a new lender

Note: If not all properties can be re-financed (due to issues such as a of given property being in a trust), the outgoing lender would want to value all properties also to ensure they have a security that is actually worth the lend for the property.

How Do I Avoid Cross Collateralisation?

Ask your broker or lender to create a separate loan split against your current property. For instance, if your loan is 300k and the property is worth 500k, at 80% LVR (80% x 500k), a $100k loan split can be created for your next investment property purchase.

This approach will mean, you will have two loan applications, with each loan contract catering for two different properties / securities:

  1.  To extract the $100k equity from your existing property and
  2.  Second application for the new investment property purchase

The benefits of avoiding cross collateralisation far outweigh the benefits for cross collateralisation. There would always be cases where crossing makes sense, however always do your due diligence and a pros and cons review of why you should or shouldn’t cross for your given deals such that whatever decision you make is aligned with your financial goals.

Happy Investing!


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