It is most common for investors to use equity in their homes to fund the home loan deposit for their investment property. However, if you intend to use your home as security for building your property portfolio, think long and strong. Using more than one property to secure your home loan may give you access to easier credit (considering all your loans are with one lender) but it will severely hamper your financial flexibility.
What is Cross Collateralisation?
Cross collateralisation or a cross collateral mortgage refers to using more than one property to secure a mortgage (or more than one mortgage). Having all your mortgages with one lender gives the bank greater control over your financial affairs and exposes you to unnecessary risk that can be avoided by taking a standalone loan.
Even if your loans are not cross collateralised but with the same lender, it gives the lender recourse to all your security in case of default on any of the loans you have with the lender.
Keeping separate securities for individual home loans is one of the best pieces of advice any astute investor will give you. And while it may be convenient to cross collateralise or have all your loans with one lender, here’s why you should avoid cross collateralisation:
1. Limited access to equity – In case your portfolio is cross collateralised, unless all the properties in the portfolio have appreciated, even significant appreciation in any one property will not have much impact on your total equity if any other property in the portfolio has dropped down in value. What this means is that increased equity in the property that appreciated in value cannot be used by you as the overall equity in the property portfolio did not increase.
2. Loss of control over sale proceeds – When a property from a cross collateralised loan portfolio is sold, banks may require the sale proceeds from the property to be applied against reducing other debts in the portfolio and nothing can be done about it! This means you have no control over the sale proceeds of your own property and may find yourself wanting in a financially difficult situation. Further, releasing a property from a cross collateralised portfolio is complex and banks usually require fresh valuations each time a portfolio is amended, leading to higher costs.
3. Increased exposure to risk – Cross collateralisation can increase your exposure to risk. In case you decide to sell a property in order to make good the loan, the lender can insist you on selling other properties in the portfolio as well, if the proceeds from the property being sold do not cover the costs of the lender. Cross collateral loans basically give lenders access to your entire portfolio increasing their sway.
4. Increased costs – When a number of properties are used to secure a loan, it involves a higher fee and also puts the bank in a stronger position. As the complexity of the portfolio increases, it becomes increasingly difficult and more expensive to switch lenders (due to the sheer number of properties involved and the accompanying valuations). Apart from high establishment fee, higher exit fee is also applicable on cross collateralised loans.
Unless you feel strongly about cross collateralising your portfolio, it is always better to use separate properties as security for separate loans. You can always take a line of credit loan using the equity in your existing home to fund the deposit for your investment home loan and avoid using more than one property to secure a home loan. Ask for a standalone loan and always check your loan contract for the property it is secured against.
With the mortgage market turning more competitive, it is possible to get lowest home loan rates through online mortgage comparison. Start by using this home loan calculator to know how much you can borrow and compare mortgage rates online to get the most competitive home loan rates in the market.