Spelling Out Cross-Collateralisation in Australian Real Estate

Australian property values have experienced a significant surge in recent years, resulting in homeowners benefiting from a substantial increase in home equity. To leverage this equity without the need to sell one’s home, cross-collateralisation can be considered. However, evaluating this approach’s pros and cons is crucial.

What is Cross-Collateralisation?

Cross-collateralisation refers to a strategy where multiple properties are used as security for a mortgage instead of having each property independently secure its loan. In other words, it involves leveraging the equity in various properties to secure a new home loan or additional borrowing.

Simply put, if you, as an investor, wish to purchase another property without using your savings, you can tap into the equity of your existing property. The bank or lender may then use both properties as collateral for the new home loan, potentially allowing you to access funds for your investment. Considering the significant rise in Australian property values in recent years, cross-collateralisation can be an attractive option for investors looking to capitalise on increased home equity. However, it is crucial to carefully evaluate several factors before committing to another home loan agreement.

How Does It Work?

To illustrate how cross-collateralisation works, consider the following scenario: Suppose you own a home valued at $800,000 and have fully paid off your mortgage, resulting in $800,000 in equity. You intend to purchase an investment property valued at $400,000, but you don’t have enough cash for a 20% deposit.

In this situation, you approach a lender and request to use your home as collateral for a $400,000 loan to acquire the investment property. If the lender approves your application, your home will secure the loan and the investment property, which have a combined value of $1.2 million. This arrangement places the lender in a secure position, as the loan-to-value ratio is 33.33%, indicating that the loan amount represents only a third of the total property value.

By cross-collateralising the two properties, the lender mitigates their risk, as they can rely on the combined value of both properties as security for the loan. This gives the lender greater assurance, potentially leading to more favourable loan terms and conditions for you as the borrower.

Is Cross-Collateralisation Legal?

Yes, cross-collateralisation is a legal practice. It involves using multiple properties as collateral for a loan and is a legitimate financing option. It can provide a simpler alternative to managing various loans with different lenders, as it consolidates borrowing into a single facility.

Pros and Cons of Cross-Collateralisation

Pros

Tax Benefits

You may claim tax deductions on your investment properties through cross-collateralisation. Suppose you’re using equity to purchase another property. In that case, there is the potential for your purchase to be completely tax deductible. Yet, it’s essential to consult financial and tax professionals to understand how tax benefits can be obtained.

Unlock Equity

Unlocking the equity in your home lets you skip the process of saving up for another deposit. It allows you to seize an investment opportunity and build a property portfolio quickly. Cross-collateralisation can make this easier and access equity for tasks like renovations.

Convenience

As you can only cross-collateralise with one lender, all your loans are in one place with the same financial institution. This can make managing your portfolio easier than having several loans across different lenders. Having one lender may also save on some fees.

Potentially Lower Interest Rates

Cross-collateralisation can give a lender more power and control over a borrower’s property portfolio while lowering its risk exposure. As such, lenders may be more inclined to offer you a lower interest rate on a cross-collateralised loan, which could save you thousands over the life of the loan.

Cons

Bank and Lenders Placed in the Driver’s Seat

Cross-collateralisation may often appeal to an investor, particularly with increasing house prices. Yet, it puts banks in a stronger position as it gives them greater control over the properties, given they are used as security.

High Valuation Costs

Because of the way properties are linked under cross-collateralisation, each property needs to be professionally valued every time there’s a substantial change to the portfolio or the loan, including every time a property is bought or sold. This can be incredibly time-consuming and costly, as having a property professionally valued can cost several hundred dollars each time.

Point of Sale Issues

If you decide to sell a cross-collateralised property, you are, in essence, altering your agreement with your bank or lender. This is because you are changing the security the lender has and potentially altering the loan-to-value ratio. In this instance, your lender will need to complete a partial release on your loan, where they would remove the property you are selling from your loan and revalue your other property that will remain with the loan.

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