Cross collateralisation - 10 reasons to avoid

People don't structure their loans property because they don't know better and they simply accept the banks telling them how it's done. Cross collateralisation heavily favours the banks. It gives them significant control of a borrowers lending strategy. Lenders can use it to force customer loyalty and use it to manage their risk at the same time. Many brokers like it because it's less work for the same amount of income and often they're trained that way by the lenders and don't really understand the consequences of what they're doing.

Lenders often refuse to release a property that you're trying to refinance or sell because another property is depending on it for additional security. Then when you do sell, rather than take your profit, they'll tell you to reduce your debt levels. Terry gave examples of people retiring who couldn't access their cash from a sale, but I've seen people much younger have their investment strategies completely derailed by similar demands from lenders.

Go back to my original point number 4. Why should the bank settle for one property as security for the loan when they can have 2 properties? It makes the banks position very comfy, no matter what happens to you, they'll get their money.

If people haven't noticed from what the brokers have been discussing for the last 2 months, lenders are becoming more risk adverse. Cross collateralisation takes your freedom and flexibility in lending and hands it to the banks. They then use it to manage their risk, not the borrowers.

There are circumstances where it makes sense to cross collateralise, but I could probably count the ways on one hand where this is the best solution. Even then there's ways to structure the loans to manage the outcome in the borrowers favour.

 

@Peter_Tersteeg

Does CC have any pro?


luckily, i don't have any securities crossed..

 

Great post.

Not in a million years would I cross-collateralise properties!

A friend of mine was able to scrape together a couple of extra purchases by crossing everything but wow...the mess it caused down the track was horrific.

 

We occasionally use it in family guarantee situations, where the first home buyer uses equity in their parents property instead of having funds for the deposit. In this scenario we isolate the parents equity contribution as a separate loan. Once this part is paid off it's fairly easy to release the parents house and the banks are fairly accommodating of this.

Years ago (shortly after the GFC) a client needed a lo doc loan and in this type of scenario it can be very difficult to release equity as cash. Crossing was a better solution than using lenders that were more flexible but had exorbitant pricing. We refinanced the entire structure to something more appropriate 3 years later when they had their tax returns under control.

Another client had an unexpected default and non conforming lenders were required. Even an 80% loan had substantial fees and high rates. A separate equity release with non confirming lenders would have also cost a fortune. A cost benefit analysis was done and another property was given as secondary security to get the average LVR down to 65% where the deal was almost priced alongside the mainstream lenders. This has reminded me to give him a call to clean it up (it's about due now).

We've currently got a few deals under way at the moment where the client is selling their existing home and upgrading. Bridging finance is another form of cross collateralisation with it's own unique set of problems. Fortunately we're not using bridging finance, but we have crossed the two properties with a loan structure conducive to an easy solution when they do sell.

IMO there is a place for cross collaterlisation, but the acceptable circumstances tend to be fairly rare. It can be used to your advantage where necessary, but the trade off need to be considered. The simple 105% loan isn't an acceptable solution.

 

Okay,

So how much did I stuff up?

I X-coll'd my PPOR with my first IP.

My PPOR was with Suncorp and they wouldn't release enough cash for a deposit on the IP I wanted to purchase.

I purchased my IP at 92% LVR

My broker told me that we would have to x-coll given my situation, especially as I took time off work to go back to uni and therefore can only show six months of employment, which is on a contract. Thus possible lenders were limited.

My actual serviceability isn't an issue and I'm in no danger of topping out at this early stage. She said that before we purchase again we will uncross the loans. She did say there would be a cost to this.

Rather than pass on IP one I decided to go for it. It was either now or in another two years as the other half wants another child; so I decided to take an aggressive approach. Waiting until after child two seemed like a bad option, both in term of mindset and strategy.

Now, it's obviously too late. But in the interests of learning from any mistakes. Did I make a mistake with x-coll?

Cheers
Beelzebub

 

Hmm, Rolf you used the term 'could'. Is it possible that the advice was sound given my circumstances? Or do you feel that would be unlikely?

 

Sound from a standard lending pov. Standard market practice, just not a good idea.

 

10 properties with $8k usuable equity each? Lender has a maximum loan amount of $8001.

Not a good idea, but it would possibly allow release of equity.

 

I'd say it's unlikely, without knowing more about your situation. Given any random situation, x-coll is not likely to be sound advice.

However, it's the advice you'll usually get when you go directly to the bank because that's what they're taught is the best way to do it. And it is the best way - for the bank.

Plenty of brokers will also do it simply b/c they don't understand the points above.

 

Highly unlikely it was necessary. Suncorps requirement for minimum employment is 3 months.

It sounds like your existing loan was already with Suncorp. Given you were able to put down about 8% and purchase costs, you probably had this available as a cash deposit. Cross collateralising means this become a single application instead of two (one of which the broker wouldn't make any money from).

With two properties it's not difficult to fix, you just need to refinance the two properties to a more appropriate structure. You likely don't need to change lenders.

 

Thanks @Peter_Tersteeg and @Terry_w

 

Thanks Peter.
I have been trapped by my bank manager for the xcoll loan.
I nearly pay off my 1st home (residential) and want to buy my 1st IP. I tell my bank not using my 1st home loan but assessing my salary status to borrow 85% for my IP as I have 15% in cash. I was told fine by the bank. But when I went to sign my paper work, I was told they need to use my home as a security reason due to the tighten policy. Until I was realized it was a trap, it was too late.

I have to pay off my 1st IP asap although I learned I need to deposit more into my offset account.

In my case, may I ask if any thing I can replan in the future? If I need to buy my 2nd IP...

My target is to hold my current home without debt, use my 1st IP to purchase 2nd IP...

 

Hi Paper, the best way to go about this is to discuss your scenario with a broker before you make your purchase. You may not be able to completely avoid debt against your current home, but it's certainly possible to reduce your risks against that property through better structuring.

Keep in mind that not every broker really understands good structuring, but it's fair to say that any of the brokers on the forum should have a decent handle on it.

I'd recommend restructuring your loans to remove the cross collateralising before you purchase the next IP, otherwise the situation is only likely to get worse.

 

It sounds like you should be able to uncross your loans pretty easily, and set it all up correctly before purchasing your next IP.

If you've got lots of equity in your home, it should be no trouble at all

 

I remember Terry_W mentioned back on SS forums that this could be resolved by calling the bank to ask for substitution of security.

Can anyone elaborate on what's involved in "substitution of security"?

From what I understand, cross-collaterisation is basically having one loan contract with two or more securities listed against it. So does that mean by asking for "substitution of security", two new contract will to be created such that each contract only list one security?

 

Substitution of security is one possible way to resolve the problem if the equity position in individual properties accommodate it. If the numbers are appropriate to this solution there's some fairly straight forward paperwork to be filled in and a bit of a process for the bank to follow.

If one of the properties was purchased recently, then there likely isn't enough equity for this to be a viable solution. You need the loan to have an LVR of 80% or less against any property it is secured against.

 

This sounds like nothing but a trap. Tightening credit policy doesn't affect the security. All BS

 

Normally, in this situation you'd do a bit of a reshuffle so instead of having a PPOR loan of for eg $50k and an IP loan of $300k all secured by both properties, (ignoring costs) it would look like this -

PPOR - original $50k loan
- $60k loan (20% of IP1)
IP1 - $240k loan