Cross collateralisation is a lending strategy used by some homeowners to help them start or grow their property portfolio. In theory, implementing a cross collateralisation strategy makes a lot of sense, and it’s convenient too: basically, you use the equity you have in one property to secure finance for another.
This strategy usually means you’ll use two or more properties as security for one loan, but the upside is that it allows you to purchase another property and continue to grow your wealth.
However, the way in which you set up your cross-collateralised structure will determine how far you can grow your portfolio. A poorly planned cross collateralisation strategy may put a handbrake on future lending and quickly derail your growth plans. A carefully planned strategy can reap some great rewards and help you reach your goals faster.
What is cross collateralisation?
Cross collateralisation happens when more than one property is used to secure a loan. For example, let’s say you own some or all of your home (your Primary Place Of Residence, or “PPOR”), and you use some of its equity as a deposit for your first investment property.
This means that you have two properties involved as ‘security’ in the mortgage for your investment property:
- part of your PPOR, and
- the investment property you’re purchasing.
There are more complex examples of cross collateralisation, involving multiple loans and different loan types, however the scenario described above is one of the most common.
What are the benefits of cross collateralisation?
Basic cross collateralisation gives homeowners the ability to buy an investment property without having to provide a cash deposit.
Two other key benefits include:
- Saving tax. The nature of cross collateralisation means that investors may be able to borrow 100% of the value of the property (instead of forking out a 20% cash deposit and borrowing the rest), which means that your purchase could be 100% tax deductible, instead of 80%. Please note, this isn’t tax advice and may not be relevant or applicable to your unique situation. Speak to your accountant for more information.
- Lower interest rates. Depending on your borrower and a few other conditions, you may be able to access owner-occupied interest rates for your investment property (due to the connection created by your cross-collateralisation).
What’s not-so-good about cross collateralisation?
At face value, cross collateralisation seems like a beneficial strategy. However, there are some downsides, such as:
- You may hit a lending ceiling. Many cross-collateralised lending environments involve one lender only. This means investors may be restricted by borrowing limits. Lenders don’t want you to borrow too much.
- Your bank may gain significant control over both properties. Depending on the nature of your cross collateralisation strategy, your lender may require that proceeds from the sale of a property be used to reduce loan balances within a cross-collateralised portfolio, instead of providing you with the profits/funds for discretionary use.
- You may be limited to “principle and interest” lending only. Some investors’ unique situations may benefit from the use of interest only loans, whereas cross collateralised structure requirements may restrict borrowers to principle and interest lending only.
- Equity concerns. When two properties are cross-collateralised, their equity calculations may be linked together. For example, if one property increases in value, and the other property decreases in value, the end-result may be a zero increase overall (as one has cancelled out the other).
A solution for avoiding restrictive cross collateralisation
Many savvy investors utilise a “home equity loan” strategy to reduce the control lenders have over their properties. A home equity loan works like this:
- Let’s say you have $250,000 of available equity in your home (your PPOR).
- You approach your lender and apply for a “home equity loan” of $250,000. Assuming you have good credit, can service the loan’s repayments, and meet the bank’s other requirements, you should be able to access $250,000 in cash.
- You approach a different bank and use this $250,000 as a deposit for an investment property.
In this scenario, you are able to purchase two properties, from two lenders, without having to cross collateralise. This gives you greater freedom for refinancing or selling etc.
Can We Help With Your Cross Collateralisation Strategy?
The quickest and easiest way to learn more about the best loan and cross collateralisation strategy is to request a Free 30-Minute Finance Strategy Session during which you will…
- Get an up-to-date picture of the lending landscape including rates, conditions, and how to structure loans for cashflow positive investors
- Gain greater clarity over where you want to be in terms of owning investment properties (and how to structure your loans to get there the fastest, safest way)
- Discover how to unlock the equity in your current properties, so you can build your portfolio – and your wealth – faster (and enjoy a better lifestyle now and in retirement)
- Discover clever, no-cost ways to save money on interest, fees, and charges — immediately
- Learn about our process to find you a better loan that will save you thousands.
This no-obligation session will be held with one of our experienced mortgage brokers.
Please be assured this will not be a thinly disguised sales presentation. On the contrary, you’ll receive our best strategic advice, specific to your situation, so you too can accumulate multiple properties without sacrificing your current lifestyle and accelerate your progress towards wealth.
Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.
Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)