What Is Cross Collateralisation?

. From refinancing to using your equity to fund the purchase of an investment property, cross collateralisation is another strategy that some investors use to build their investment portfolio.

When it comes to investing in property, it’s worth knowing your options for purchasing any potential investments. From refinancing to using your equity to fund the purchase of an investment property, cross collateralisation is another strategy that some investors use to build their investment portfolio.

Read on to learn more about cross collateralisation, how it works and the pros and cons of this approach.

A breakdown of cross collateralisation

While collateral refers to using your property as collateral or security to buy another property, cross collateralisation is the process of using the equity in two or more properties as security for a loan on another home.

Cross collateralisation is an alternative method to the traditional approach of having one property for one mortgage. It’s a way to purchase an investment property without stumping up the bill with your cash savings. Instead, you use your home equity to purchase an investment property.

It’s worth noting that you can only cross collateralise with one lender, which is why this approach is often considered riskier than alternative methods.

How does cross collateralisation work?

The easiest way to understand how cross collateralisation works is with an example.Let’s say you own a home that’s worth $600,000. You still owe $300,000 on your mortgage, meaning your home equity is sitting at $300,000 and you have a loan-to-value ratio(LVR) of 50%.

You’re on the hunt for an investment property, but you don’t have the cash to cover the deposit. Instead, you could approach your bank to use the equity in your existing home loan to fund the purchase of an investment property. If you find an investment property that costs $300,000, you may be able to use your home as collateral for a $300,000 loan to buy the investment property. If you get the green light, you’ll have $900,000 worth of property, $600,000 worth of debt and an LVR of 66.66%.

As your home equity builds in the second property, you might be able to use that equity to fund the purchase of another investment property allowing you tobuild a property portfolio. From this point, the cross collateralisation begins with equity in two properties being used to fund your portfolio. With thatsaid, the more you cross collateralise, the tighter your borrowing power becomes. This can ultimately make it increasingly difficult for you to purchase more investment properties without providing additional security in the form of actual savings.

What are the benefits of cross collateralisation?

But it’s not all bad news, cross collateralisation can offer several benefits for budding property investors, including:

  • Potential increased borrowing capacity: Cross collateralisation could allow you to increase the equity in your portfolio. Although, this is subject to market conditions.
  • Access to additional funds: You can leverage the equity in existing properties to access additional funds without providing new collateral. This can be particularly useful for funding renovations, expansions or the purchase of additional investment properties.
  • Potential for lower interest rates: By combining multiple properties as collateral, you may negotiate more favourable loan terms, including potentially lower interest rates.
  • Save your cash: By using the equity inyour existing properties, you don’t have to draw on your cash savings. This isalso a benefit if you’re asset-rich but cash-poor and don’t have the funds fora deposit.

It's important to note that while there are advantages, there are also potential risks associated with this strategy.

What are the disadvantages of cross collateralisation?

If you’re thinking of using cross collateralisation to fund your investment strategy, it’s important to be aware of this approach's potential risks and drawbacks.

  • Reduced flexibility: Cross collateralisation can potentially reduce your flexibility to make independent decisions about each of your properties. In some cases, you might be limited in using the properties as collateral for other financial transactions or investment opportunities.
  • Complex loan terms: Managing multiple loans with different terms and conditions can quickly become incredibly complex. It’s essential that you carefully track payment schedules, interest rates and other loan terms for each property.
  • Challenges selling: Selling properties that are part of a cross collateralisation agreement is often more challenging compared to other loan setups. Because each of the properties are intertwined, you might need to negotiate with the lender to release the collateral tied to a specific property before selling it.
  • Less control: Cross collateralisation can limit your control over individual properties. Decisions related to selling or refinancing one property are often much more complex and can be subject to the lender's approval.
  • Difficulty refinancing: With all your properties tied up in a cross collateralisation structure, the complex nature of this setup means that you could face difficulties if you’d like to refinance with another lender. Plus, you’re more likely to be hit with higher refinancing costs to try and unravel such a convoluted portfolio.

Before using cross collateralisation to fund an investment property or even build a property portfolio, it’s important to carefully weigh up the potential benefits against these risks. Are there alternative investment strategies that could be better suited to your circumstances, investment goals and risk tolerance? In this instance, it could be worth calling in a professional, like a financial advisor, mortgage broker or legal expert, for tailored advice.

This article is intended to provide general information only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice.Please consider seeking financial advice before making any decision based on this information.

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