Cross collateralisation - 10 reasons to avoid

I have done this.

I had an unencumbered PPoR and I wanted to by an IP at a 105% LVR lend. I got one loan for the 105% amount, I think it was $485,000. On the loan documenation for the IP purchase, under the section for security, it listed the address of the PPoR and the address of the IP.

As discussed above, there are many disadvantages to this scenario. Worst case is if I had to sell the IP at a loss and could not cover the shortfall, I would lose my PPoR. In my case, 3 years after I bought the IP, I refinanced to another lender and uncrossed the loan at the same time.

 

Yes.

What is an 'equity release'? you can only borrow money, not release equity. And you can borrow money by 2 ways:
1. LOC or
2. Term loan

A term loan is ok as long as the money can be deposited into and redrawn from the loan account. If not then use a LOC first up, once it is drawn convert it to a term loan (to avoid the repayable at demand clauses)

 

Lol oh now I understand. Looking back, my question really proves how green I am with all this.

Sorry for all the questions, but what is the repayable at demand stage?

Thank you so much to everyone for the insightful information ☺

 

Term loans are for 25 or 30 years. The lender cannot ask you to pay the loan back early unless you have breached the terms.

A LOC is generally different. It could be called in without the borrower breaching any terms. Rare, but possible. I have heard of LOCs being cancelled if not being used, but not heard of one being called in.

 

No need to apologise. Keep asking questions until you understand this. Having the proper finance structures in place is the key to growing a property portfolio. Besides that, other people reading also benefit from the answers... ;-)

 

Thanks Perth Guy. Like they say, the only silly questions are the questions that aren't asked

 

Right, I'm bookmarking this thread and I hope it's made into a sticky. This is one of the most straightforward explanations I've read of why x-coll is bad - previously I didn't fully understand why. Thanks Peter for kicking off this discussion.

 

Was just wondering why this thread hasn't already been stickied!

Friend has been xcol'd by his broker, not 1 but 2 IPs as additional security... settlement too close to fix but have pointed him in this direction as I believe it's the best place for him to ask questions. Hopefully he can uncross later, although I've heard uncrossing is hard?

 

It depends - it can go from easy to easy-but-expensive to difficult depending on the situation.

 

I think numbers are roughly IP LVR=50, PPOR LVR=90, total LVR=70

 

Easy Assuming just the 2 properties, but I thought there were 2 Ip's?

 

2 IPs, both with LVR~50, used as additional security on PPOR loan (so 3 properties as security)

IP equity release would have been a cleaner (albeit non-deductible) way to do it, can he simply stay with the same bank and request a reshuffle? Or is that hard to do without contaminating the IP loans as they currently exist?

 

Was the PPOR bought last using equity from the IP's? Or was the PPOR equity used as deposit for the IP's?
It's probably fine to stay with the existing lender, although knowing the deal in more detail might suggest it's not the best outcome.

Depending on the values of the properties it looks fairly straight forward.

 

Sorry for skimping on the details....

IP 1 and IP 2 with lender 1, end up at LVR 50 each
Purchase PPOR with lender 2, on condition that both IPs are refi'd and xcol'd with lender 2

So IPs were used as security for PPOR purchase but not sure if this counts as "using equity"

 

Who's the lender? NAB?

 

Macq

 

It should be straight forward to uncross. I find it hard to believe Macq would make bringing the IP's across and x-colling them a condition though - did he use a broker?

*Edit - just saw that he did. I'd say it's far more likely his broker wanted them done that way than it being a 'condition'.

 

Technically it was a condition... of getting a 90% loan on new PPOR without LMI Not an absolute condition of finance but he's not an SS/PC regular so he probably just followed his broker's suggestions... none of which was equity release apparently

 

Hmmm....I see. It would be interesting to have a look and see if it's possible to refi his PPOR to WBC with their new no LMI deal and untangle him at the same time. Everyone wins! (Except the old broker. )

 

I completely agree with you.

Other disadvantages are:

If you default, the bank chooses which property to sell and not you, and that might be the property live in but most likely the one that can easily be sold.

I do not disagree with you at all... but your comments are for the unprofessional investor....

I started out cross collaterizing my unit to buy a block of land..... then took out a construction loan, build the house, got it revalued, refinanced and paid off the loan and eventually separated the two properties. Right now, all of my properties are on separate loan contracts... which give me the choice of which one I default on (if it came to that) so that the bank can sell that one... and I can tell you it will be the unit... worst mistake I made buying it.

But with the right loan structure, there is cashflow from all properties going into the nondeductible and therefore you only pay one loan rather than say multiple to put pressure on you financially. Therefore, with this setup, there would be no reason to sell at all... and it perpetual.... I have approached a finance company to be the catalyst to catapult me into the next. Again, doing this is bad when you have to pay off all loans at once... but having to only pay off one loan at a time... makes it a lot easier... the upside is that the total equity of the combined properties will allow me to buy further cashflow positive properties to augment the same to pay down the non-deductible faster to move on to the other loans.