Pros and cons of cross collateralisation for property investment
What is cross-collaterisation?
Cross-collateralisation is the process of utilising more than one property as security for a mortgage rather than the traditional one property for one mortgage.
To put it simply, you as an investor may be looking to purchase another property without using any of your savings, rather tapping into your property equity. The bank or lender can then use both properties as collateral for a new home loan.
Given the growth of the Australian property market in recent times, taking advantage of an increase in home equity may be appealing to investors through cross-collaterisation, yet its important to weigh up a number of factors before signing another home loan contract.
How does cross-collateralisation work?
As an example let’s say your home is worth $800,000 and you’ve paid off your mortgage, hence you have $800,000 in equity. You decide you want to buy a $400,000 investment property but you don’t have the cash for a 20% deposit. So you go to a lender and ask to use your home as the security for a $400,00 loan to buy the $400,000 investment property. If approved, this means that this one loan is secured by two properties worth a combined $1.2 million, putting the lender in a very safe position with a loan-to-value ratio (LVR) of 33.33%.
Pros and cons of cross-collateralisation?
Pros
- Tax benefits: You may be able to claim tax deductions on your investment properties through cross-collaterisation. If you’re using equity to purchase another property, there is the potential for your purchase to be completely tax deductible, yet it’s important to consult financial and tax professionals to understand how tax benefits can be obtained.
- Unlocks equity keeping savings in your back pocket: Unlocking the equity in your home lets you skip the process of saving up for another deposit and affords you the convenience of quickly seizing an investment opportunity and building a property portfolio. Cross-collateralisation can make this easier to do, as well as accessing equity for tasks like renovations.
- Convenience: As you can only cross-collateralise with one lender, all of your loans are in one place with the same financial institution. This can make your portfolio much easier to manage, rather than having several loans across different lenders. Having one lender may also save on some fees.
- Potentially lower interest rates: Cross-collateralisation can give a lender more power and control over a borrower’s property portfolio while lowering its risk exposure. As such, lenders may be more inclined to offer you a lower interest rate on a cross-collateralised loan, which could save you thousands over the life of the loan.
Cons
- Bank and lenders placed in the drivers seat: Cross-collateralisation may often be an appealing option to an investor, particularly with house prices continuing to climb, yet it puts banks in a stronger position as it provides them with greater control over the properties given they are used as security.
- High valuation costs: Because of the way properties are linked under cross-collateralisation, each property needs to be professionally-valued every time there’s a substantial change to the portfolio or the loan, including every time a property is bought or sold. This can be incredibly time consuming and costly, as having a property professionally valued can cost several hundred dollars each time.
- Point of sale issues: If you decide to sell a cross-collateralised property, you are in essence altering the agreement you have with your bank or lender. This is because you are changing the security the lender has and potentially altering the loan-to-value ratio. In this instance, your lender will need to complete a partial release on your loan, where they would remove the property you are selling from your loan, and revalue your other property that will remain with the loan. Keep in mind there is no guarantee that the property remaining with your loan will solely meet the requirements of that loan (i.e. LVR requirements) and your lender may require you to refinance or sell the other property in extreme circumstances.
Factors to consider before cross collateralising
It’s common for property investors to diversify their portfolio with home loans across multiple lenders given using one bank or lender can potentially place all the power solely in their hands. A way around this is to take out separate loans for each new property with the deposit and costs coming from an established line of credit or offset account.
Cross-collateralisation may be a good option to score a better owner-occupied rate and avoid having to dip into your own savings to buy an investment property. That being said, it’s important to carefully weigh up the pros and cons as to what is best for your current financial position and to consider seeking financial advice to help determine the loan structure that suits your circumstances.
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