If you go to any residential property forum you’ll invariably see discussions about cross collateralisation. They range from newbie investors not realising the consequences of what their lender has done to them, i.e. cross collateralised their loans, to examples and strategies on how to ‘un-cross’ loans.
What is cross-collateralisation?
Cross-collateralisation occurs when more than one property is used to secure a loan.
For example, a person owns Property A and wants to purchase Property B without using any of their own funds. The bank can use both properties as collateral for the new loan.
Many investors have cross-collateralised loans without knowing it. One way to determine if loans are cross-collateralised or stand-alone, is by checking the detail in the loan contract. There will be a section in the body of the contract which will note the addresses of the properties over which the lender holds or will register its mortgage.
Loss of Flexibility
Most buy and hold investors eventually come to the realisation that having your loans ‘crossed’ reduces your flexibility in dealing with each of your properties individually, e.g. if the value of one of the securities (properties) drops, this may effect your ability to sell the other security (property). Nasty, if your plans revolve around selling a specific property.
Even Worse For Vendor Financiers?
When you sell a property with vendor finance it’s important the property is not security for a ‘crossed’ loan. This is because, no matter if you sell with a Rent To Buy or an Instalment Contract, you always have to be in a position to give free and clear title to the property at any time.
This is because your buyer is entitled to payout an Instalment Contract at any time and your tenant/buyer can ‘exercise’ the Option in the Rent To Buy at any time.
Payout to Release Title Keeps Changing
When a loan for a property is cross collateralised you’re never sure what the lender is going to insist is paid, before they’re prepared to release title for the property that your buyer wants to complete their purchase of. And as property values vary, this amount can vary from month to month and year to year. Ultimately the bank makes the decision and if they want more than your buyer owes you, you’re in deep you know what.
We have seen vendor financiers come unstuck with this and that’s why we now will not normally apply our Negative2Positive process to properties that are a part of a ‘crossed’ loan.