Cross-collateralised loans are loans where an investor uses more than one property as security for a loan from the same lender.
It’s often one of the biggest mistakes investors make because they generally give up a great deal of flexibility, handing too much power and control to the lender.
But while there are a number of risks, in some cases there may be benefits as well.
Here’s what property investors need to know.
What a cross-collateralised loan looks like
Let’s say Eric owns a house worth $1,000,000.
He took out a loan with NAB and currently has $700,000 worth of equity in the property.
Eric decides he wants to expand his portfolio with an investment property worth $600,000.
So he goes back to NAB to secure a second loan, using his initial property as collateral.
He now has two properties worth a total of $1.6m and carries $900,000 worth of debt.
But what he has overlooked is that his cross-collateralised loans have tied him very tightly to the NAB, and at the mercy of a single bank.
A smarter way to building your portfolio
Smart investors spread their borrowings among different lenders.
It gives them greater room to move and doesn’t put all their investments at the behest of a single lender.
What Eric should have done is approached the NAB for a home equity loan of $420,000 made up of the balance he owes on his initial property ($300,000) and the deposit he needs for his investment property ($120,000).
He could have then approached a second lender with the necessary 20% deposit in hand, while also shopping around for the best possible rate.
It would have also given him the added benefit of not tying his investment property to his home with the one lender.
Benefits of cross-collateralised loans
It’s risky business but there are some benefits of cross-collateralised loans.
Here’s what usually draws people in:
Lower interest rates – Because they control all of your investment portfolio, lenders may see you as a lower risk and may offer you a lower rate.
Potential tax benefits – If your initial purchase is an owner-occupied property and your second purchase is an investment property, you should be able to claim a tax benefit.
The equity you are using from it should be fully deductible.
Downsizing – It can be a good strategy if you plan on downsizing from your initial property to your smaller investment property, purely for the simplicity of dealing with one lender.
Risks of cross-collateralised loans
It’s important to understand that your lender will probably recommend you cross-collateralise.
They want as much of your business as possible and it reduces their risk.
It’s in their best interests but it may not be in yours.
Here’s why:
Market downturns – These can have a devastating effect on people who have cross-collateralised loans.
If one property falls in value, your lender may force you to sell one or both of your properties because they are linked.
It triggers a domino effect of the worst kind.
Even a drop in one of your properties could put your equity and your portfolio in jeopardy.
Risking your home – If you fall behind in your loan repayments on your investment property, your lender could force you to sell your home!
That’s because your properties are tied to the same lender.
It gives them the right to tell you which loan and how much to pay in order to keep your loan-to-value ratio within their acceptable limits.
Refinancing means revaluing – If you’re not happy with the current rate you are paying on one of your properties and want to refinance, you’ll need to reapply for ALL of your loans.
It gives your lender the right to revalue all your properties in the process.
This can be costly, time-consuming and risks you having one or more of your properties valued lower.
It may even prohibit you from refinancing at all.
More expensive LMI – The higher your loan with a single lender, the more Loan Mortgage Insurance (LMI) you will generally pay.
Hence cross-collateralised loans normally attract much higher LMI premiums than standalone loans.
Difficulty of refinancing – Lenders know it is difficult to refinance when you have cross-collateralised loans.
That’s why they encourage it – to retain your business and gain greater power over your investments.
Restriction of loan repayments – Your lender could restrict you to particular loan types such as principal & interest (P&I) repayments instead of interest only.
This may restrict you from building your portfolio until you are able to reduce your LVR to close to 50% and increase your savings.
Get advice now
Investing in property is one of the safest and reliable ways to grow your wealth in the long term.
But there are traps and pitfalls to be made along the way, especially by the novice investor, so it is crucial to work with an experienced mortgage broker to help you design the right finance strategy, with the right lenders, for you.
Everyone’s plans, hopes and dreams are uniquely different, so investors really need a bespoke strategy.
That’s where Calder Finance Broking and Calder Wealth Management can help.
Calder Finance are specialists in the mortgage broking business.
We have formed trusted connections with hundreds of bank and non-bank lenders.
Our vast array of contacts within the industry allow us to offer our clients the most attractive rates, tailored to their specific needs.
At Calder Wealth Management, our financial experts can ensure your investment strategies are sustainable and help not just create but preserve them for the long term.
If we think you are better served by cross-collateralised loans, we’ll tell you!
We pride ourselves on leading our clients into the future with structure, financial stability and confidence.
Contact us today to discuss all of your financial needs and mortgage requirements.
The information contained on 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 David Titley 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.