Cross Collateralisation vs Standalone: What is the best option?
Neither involve the transaction of physical cash but instead use equity from existing portfolios.
Cross collateralisation is the term used to describe when two or more properties are used to secure another loan by the same lender. When you have loans cross collateralised, the lender in question is securing the aggregate of all your borrowings with the total of all your security.
However there are some negatives associated:
Loss of control
If one of the properties is sold it is the lenders decision how the funds are used, not the investor. Often they will use the proceeds to reduce debt on the portfolio to keep LVR to a certain level.
Lack of flexibility
As all the properties are tied, the performance of one can affect the equity of the whole portfolio. If one property experiences a capital gain but others decrease in value, the net effect may be nil. Therefore you cannot access the equity in the improved property as the portfolio’s overall equity did not increase.
Every time a property is released the whole portfolio needs to be revalued so the bank can determine its risk with the remaining investments. The costs associated with this can be expensive plus there is also a range of time consuming paperwork involved.
A stand alone mortgage is when you take up an additional loan using the equity from your existing property. The loan is therefore is registered on its own, so it is not added to the original mortgage.
This results in the following benefits for the investor:
Dictate what to do with sale proceeds
The main advantage over cross-collateralisation. By keeping all properties as stand alone, the investor is flexible in what and when they can sell as well as being able to use their proceeds how they wish.
Save on valuations
There is no need to complete a reassessment of your position with the lender, and also no requirement to do valuations on the remaining properties. Thus no need to budget the costs associated.
Unlike cross-collateralisation, you can access the equity from property value as it increases. As one properties performance does not affect the rest of the portfolio, you have the flexibility to plan and strategise your next investment decision.
Cross-collateralisation may often seem to be an appealing option to an investor, but it puts lenders in a stronger position as it provides them with greater control over the properties. While not having to use your own cash to acquire the second property may seem appealing initially this strategy has the potential to negatively impact future investment opportunities. It should only be considered if the equity in your existing property cannot acquire the finance you require.
As a stand alone mortgage provides greater flexibility and allows you control over equity and sale proceeds we strongly recommend it over crossing your properties.
Speak with our friendly team at Finance Detective by calling (08) 9289 7777.