If cross-collateralisation isn’t on your agenda as a property investor your wealth plans could be at risk, says Adelaide mortgage broker Hayley Walsh.
Cross-collateralisation is quite the mouthful.
And it can leave Adelaide property investors in quite a pickle if they haven’t thought long and hard about their property investment strategy.
Many investors may be cross-collateralising without even knowing it. While others may do it without fully understanding the risks.
So what exactly is it and why should you be wary of it?
Cross-collateralisation defined
Cross-collateralisation is when an investor uses more than one property as security for a loan.
Let’s say Adam buys his first house with BankSA for $1,000,000.
After a period of time, he has paid off $600,000, leaving $400,000 owing on the property.
Adam then decides to buy an investment property worth $500,000.
By taking out this second loan with BankSA, he is cross-collateralising.
That’s because BankSA have first mortgage security over both properties.
The total value of his assets is now $1,500,000 and he owes $900,000 on both properties.
Another few years pass. Adam has paid off another $200,000 and decides he wants to continue to build his property portfolio by buying another investment property.
With $700,000 still owing on his two properties, BankSA may not necessarily look favourably on another loan application.
Adam is now in a bind. Another lender is unlikely to fund his application either with BankSA holding first mortgages on the two properties he already owns.
Adam’s only play would be a potentially expensive dissolution of his two mortgages with BankSA, moving his entire loan portfolio to a new lender who would then have security over all three of his properties.
What Adam should have done was take out a new loan for his first investment property with a new lender.
Here’s why.
The risks of cross-collateralisation
Cross-collateralisation can cause big problems in a big hurry.
It restricts your flexibility and can potentially end in disaster.
The bank controls your destiny – If times get tough and you start to struggle to meet your loan repayments, the bank has the power to decide which property must be sold to bring your loan-to-value ratio (LVR) within acceptable levels (this is usually 80% or less).
This means the bank could force you to sell your home rather than your investment property!
Market corrections – If all of your investment properties are linked and there is a significant drop in the value of just one of those properties, the overall impact on your portfolio can be devastating.
It can erode any gains in the value and equity in other properties within the portfolio, leaving you a net value of zero.
This could restrict your access to cash or ability to further invest.
House prices in major capitals including Sydney and Melbourne have suffered corrections in 2022 after a significant property boom.
Refinancing challenges – If you wish to refinance to access equity or switch to a better package with a more attractive interest rate, all properties within your portfolio must be revalued.
This can be a costly and time-consuming exercise.
It also carries the danger that one of your properties is valued lower than expected, preventing you from refinancing.
Changing lenders – This can be extremely difficult and expensive if you have cross-collateralized.
That’s because loans with multiple properties tend to attract exit fees, especially if any of the loans are fixed.
Refinancing may also prove difficult if:
- your financial position has changed, such as if you are self-employed.
- your LVR does not satisfy your new lender
- the properties in your portfolio do not satisfy your new lender, for instance if you had several high density inner-city apartments.
Principal and interest – As your mortgage exposure with one bank expands, it is possible your choice of loans may become more limited.
Your bank could force you onto a principal and interest loan rather than interest only.
It may then not be wise to expand your portfolio until reducing your LVR to around 50-60%.
Hence, investors planning to purchase multiple properties are better off using multiple lenders.
The benefits
Despite all the potential risks, there may be some benefits to cross-collateralising.
Lower interest rates – A bigger mortgage with one lender generally avails you a slightly lower interest rate.
If you live in one of your properties, you should be able to find an owner-occupied rate that is more attractive than an investment rate.
Even a small difference in the rates may equate to vast sums of money on big mortgages.
Tax benefits – If you use your equity to purchase an investment property, the interest paid may be tax deductible.
You may lose some of that tax advantage if you use some of your own savings to partially secure an investment loan with a new lender.
Downsizing is easier – It makes life easier if you are not planning on buying multiple properties and have bought a townhouse or unit with a view to downsizing to it later in life.
But given the risks, it will pay to speak to a finance expert about your personal situation as soon as possible.
Get advice today
Cross-collateralising is generally not recommended, which is why it is important to get the best possible advice and the right finance strategy before buying your first investment property.
Calder Finance Broking are specialists in the business of property finance.
We can advise you on the most prudent strategies for your situation and help you find the very best loan deals on the market.
We pride ourselves on leading our clients into the future with structure, financial stability and confidence.
Contact us today to discuss all of your finance needs and concerns.
The information contained in this article is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.
Taxation, legal and other matters referred to on this website are of a general nature only and are based on Calder Wealth Management’s interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice. Those laws may change from time to time.
Calder specialises in wealth management with a focus on advice, investment, sustainability, insurance and finance.
Written by Hayley Walsh from Calder Finance Broking, for more information please visit the Calder Finance website. Please note that Calder Finance Broking Pty Ltd is a Corporate Credit Representative of BLSSA Pty Ltd ABN 69 117 651 760 ACL 391237.
