Cross collateralisation - 10 reasons to avoid

Noobie question here, sorry.

Ok so I kind of understand now what x-coll is. Its using one property to secure another one. But I'm getting abit confused. I read that the best way to structure is to get an equity release loan from your ppor and use that as a deposit for the IP. But what's confusing me is, isn't this strategy using one property to secure another property? Or am I just getting really confused. Alot of information to absorb today by me lol

 

Not quite. Cross collateralisation is when you use two or more properties to secure a loan.

An equity release means that an investment loan may be secured against a different property to what it's spent on, but it's only secured by a single property.

It doesn't matter so much which property is used as security for a loan, the important thing is that only a single property is used as security of any loan.

 

Question:
Say you own 5 IP's each with 20k useable equity, you need 100k deposit for IP6. Would this be structured:
IP1 Loan + IP1 20k equity release loan. Both loans secured against IP1.
IP2 Loan + IP2 20k equity release loan. Both loans secured against IP2.
Same for IP3-5.

You then get 5 * 20k bank cheques from each release and pay the deposit.

The final loan is IP6 secured by its seperate loan?

In the Margret Lomas book I read a couple of years back she advocates a master limit where this would be easier to achieve but obviously you would then have a X Coll nightmare.

 

Pretty much. There's a lot of work involved in that scenario!

Cheers

Jamie

 

Thanks Jamie, and no doubt a lot of additional fees. Jut out of curiosity how would you do this?
Tell the client to wait until they have more equity?

 

I've never been in this situation (ie. equity pull from 5 properties to purchase another).

Most has probably been 2 or 3.

Having said that - if it has to be done, it has to be done.

 

Thanks Peter for the clarification .
Can you please give me an example of how you might have a cross collateral if you had a ppor and one IP. Or does cross collateralisation only occur when you have more than one IP because you would need at least 2 properties to secure 1 property for it to be called x col

 

Jaime, do most people only use equity from one of their IP to purchase another property? How do people end up with so many IP so quick? What is the better strategy to adopt when aiming for something like this?

 

You've got your own home worth $600k but only owe $200k on it. You're purchasing another property worth $400k. The purchase costs (stamp duties, etc) will be about $20k. The total cost to purchase the property will be $420k.

You approach your bank and they tell you that you can borrow the full purchase price as well as the purchase costs. They give you a loan for the full purchase price and costs of $420k. They don't even charge you mortgage insurance!

The problem is lenders will only give you 80% of the purchase price without mortgage insurance, and with mortgage insurance the maximum they'll lend is 95%. So how are they able to lend you 105% of the purchase price?

They've used your own home as security for this loan in addition to the new property. The combined value of the two properties is $1M and you've borrowed a total of $620k. Your total LVR is 62%. By using two properties as security for the new investment loan, the bank has cross collateralised the properties.


Instead you get some decent structuring advice. You use your home to secure an investment loan for $120k. This covers the purchase costs of $20k and 20% of the purchase price which becomes your deposit. This loan is only secured by your own home, but it is for investment purposes.

You then get a second loan of $320k for the remaining 80% of the investment property. This is secured solely against the the investment property. The overall loan structure is as follows:

PPOR (worth $600k):
* $200k (original loan, not tax deductible).
* $120k (equity loan, for the purpose of buying an IP, fully deductible)
Total LVR 53%.

IP (worth $400k):
* $320k (new loan for the IP, fully deductible)
Total LVR 80%

You don't need to use your PPOR to secure the $120k equity loan, this can come from any property that has enough equity in it.

 

Peter, Thank you for breaking it down for me. It makes so much more sense now!!!

If the banks were going to us your ppor to secure the loan for the the IP, do they have to tell you that they will be using your ppor as security? Or are you suppose to know yourself from the way it's structured? I hope they would inform you before hand or people like me wouldn't even know it was happening

 

That's true - people often don't realise they've been x-colled until much later. It's easy to check though - in your loan documents under 'Security' it will show which properties are securing the loan. If there's only one, that's good. If there's 2 or more it's bad and you'll probably want to get the loan reworked before you sign the papers.

 

Solid post and thread Peter, thanks for sharing. Should be considered for *sticky thread* material whereby every new member sees this first along with Terrys commandments.

 

It seems they often don't tell people they're cross collateralising. They tell borrowers they're going to give them a loan for the full purchase price and costs, the borrower says, "Awesome", they sign the documents.

Many bankers and brokers don't even understand the negative implications on the borrower of cross collaterlisation, they're simply trained to do it (because it works in the banks favor). If the banker or broker doesn't understand it, why would they disclose it.

 

That's abit sad when even your broker might not know the implications, so they have the best intentions but in the end you're still screwed by it

A friend of mine just refinanced his ppor. I don't really know the specific details but he told me that to get a 1% discount on his rate, he had to increase his loan to over $700k. So what they did was get a loan for the house and then a LOC to bump the total loan value over $700k. The idea from his broker was that the LOC can just sit there until they decide to buy their first IP. At least they will have the money for the deposit all ready and willing to go when they do decide to buy an IP. Would this be cross collateralisation?

 

It doesn't sound like it, as the only security is the PPOR.

If he then uses the LOC to buy an IP through the same lender, they might x-coll the PPOR and IP at that point but it sounds like so far so good.

 

That's good to hear. Just as long as he doesn't use his ppor to secure the 80% loan for his future IP, he should be fine right. I should tell him to keep an eye out when the day comes

 

Not crossed and a good idea.

 

Terry do you think it's better to get a LOC for the 20% deposit of the IP rather than an equity release loan? Or are they essentially the same thing?

 

Hi Peter:
If in the situation, has cross collateralising below by the bank 1)+2)
1) 1st home loan 300K nearly payoff;
2) 1st IP loan 350K(including bank fee, registration fee...)
3) Deposit into 1st IP 50K;
what will be the next step to get rid of cross collateralising and restructure for 2nd IP in 2 yrs (plan)?
Please advice.
Thanks

 

Equity release is a concept. A line of credit is a product which can be used to achieve an equity release outcome. I prefer to use the term equity release in these types of posts because the best solution may not be to use a LOC product.