Whats Happening in Finance and Property Investment

Cross Collateralisation - What you don't know can hurt you.

John Smith - Wednesday, August 20, 2014

For a long time property spruiker's have used  the fear of cross collateralisation to get you to use their finance staff, which means they also have your financial details and that allows them to qualify you for property purchases.

Overall I am not against this, as cross collateralisation can be a problem, however in the majority of the cases the spruiker's and their finance staff only half understand the cross collateralisation risk.

There are actually two types of cross collateralisation -

1) The first cross collateralisation that everyone talks about, is where the bank or lender agrees to give you a larger than 80% loan to purchase a second property, however they actually link the loan to your first property, so the total LVR (Loan to Value Ratio) is actually lower than 80%. Normally any loan larger than 80% attracts an LMI (Lender's Mortgage Insurance) fee which can be quite high.
Example
1st Property worth $100,000
2nd Property buying for $100,000
Loan of $90,000
Instead of paying LMI, the bank cross collateralises the two properties, so now its a $90,000 loan against $200,000 worth of securities, which represents a 45% LVR.

Its fantastic you have avoided the LMI, however it causes real problems if-

a) You want to sell one of the properties and you are expecting a certian amount of cash back. Because they are cross collateralised the lender has the choice of how much cash you will get. They may decide to pay off the loan instead, of you getting most of the cash. They have the choice, you don't.

b) You see a good rate with another lender, or want to get further cash out of your property, so you go to refinance one of your properties, and the next minute your new lender advises you that the old lender wants to repay all of the existing loan, even though you intended to leave that loan and one security with the old lender.

And yes I have seen this happen quite  few times, and also cases where the borrower did not even know the lender had cross collateralised the properties.

2) The second not rarely known about cross collateralisation, is just using the same bank for all of your property loans. Even though each property may have it's own loan completely separate from every other property, there is still a form of cross collateralisation within the loan documentation call the "All Monies Clause"

The "All Monies Clause" basically say this - "All debts are secured by all properties" or "A default on one property is a default on all properties"

In other words if you are late with a payment or default on any loan, then basically you are in breach of all loans, and the bank has the right to sell whichever property they deem to be the best property to sell to get their money back. That may be your own home!

In fact if you had a credit card with that same lender, and you failed to make your payments, then that is a debt to the lender, and all loans are then in breach.

Summary: Cross collateralisation is something you should try to avoid, however a little cross collateralisation is OK if unavoidable. Don't go overboard trying to avoid it to your financial detriment. If there are some large costs involved, wait until you need to do something, where breaking the cross collateralisation now makes sense.