When managing multiple properties and home loans, cross collateralisation is a term that often arises in the world of property investment. Cross collateralisation occurs when more than one property is used as security for a loan. While this can be useful for securing finance, it also poses certain risks for property owners. In this blog, we’ll explain what cross collateralisation is, the disadvantages it can bring, how to remove it in Australia, and provide an example to help you understand it better.
What is Cross Collateralisation?
Cross collateralisation occurs when more than one property is used as security for a loan or multiple loans. In other words, the equity in your properties is combined to back your mortgages. This method is commonly used by lenders when borrowers have multiple loans, as it gives the lender more security by spreading the risk across several assets.
For example, if you own two properties and wish to purchase a third, a lender may use the equity in both of your existing properties to secure the mortgage for the third property.
What are the Disadvantages of Cross Collateralisation?
While cross collateralisation might seem like a convenient way to leverage the equity in your properties, there are several disadvantages to consider:
- Loss of Flexibility
- One of the key drawbacks is the lack of flexibility in managing your loans. Since all properties are tied together, it can be difficult to refinance, restructure, or sell one property without affecting the other properties linked to the loans.
- Higher Risk
- In a cross collateralised setup, if the value of one property drops significantly, the lender may require you to provide additional security or reduce the loan. The risk is spread across multiple properties, meaning the performance of your overall portfolio can influence your entire loan arrangement.
- Complex Loan Management
- Managing loans across multiple properties can become complex, especially when dealing with different interest rates, loan terms, and repayment structures. Cross collateralisation often ties these aspects together, making it more difficult to manage each property’s finances individually.
- Limited Access to Equity
- You may face challenges if you wish to access the equity in one property. To release equity, the lender might require a reassessment of the entire cross collateralised loan portfolio, making the process longer and more complicated than if the properties were mortgaged separately.
- Restrictions on Selling Property
- Selling one property can be difficult under a cross collateralisation arrangement. If you decide to sell, the lender may insist that you pay off a portion of the loan on other properties, even if they’re not directly linked to the property being sold.
For property investors, these disadvantages may outweigh the benefits, particularly if you intend to expand your portfolio or maintain flexibility in your loan structures.
How to Remove Cross Collateralisation in Australia?
If you’re currently in a cross collateralisation arrangement and want to regain control over your individual properties, it’s possible to remove cross collateralisation. Here are some steps you can take:
- Refinance Individual Loans
- The most direct way to remove cross collateralisation is to refinance each property with separate loans. This allows you to unlink the properties and regain flexibility. You might need to shop around for a lender willing to refinance your loans independently. To assess the feasibility of refinancing, use an investment loan calculator.
- Increase Loan to Value Ratio (LVR)
- If the value of one or more of your properties has increased, you may be able to boost the loan to value ratio (LVR). A higher LVR means a larger portion of the loan is covered by the property’s own value, reducing the need for cross collateralisation with other properties.
- Pay Down Debt
- Reducing the loan amount can help ease the lender’s reliance on cross collateralisation. By paying off part of the loan on one property, you may be able to remove it from the portfolio.
- Seek Expert Financial Advice
- If you’re uncertain about how to remove cross collateralisation or how it could affect your property portfolio, seeking advice from a financial expert is a smart move. They can guide you through the process and offer strategies tailored to your specific circumstances.
At Alegio Partners, we specialise in helping property investors navigate complex mortgage structures, including removing cross collateralisation. We can help you refinance or restructure your loans to maximise flexibility and control.
Here is an Example
Let’s say you own two properties in Melbourne:
- Property A is your primary residence, and
- Property B is an investment property.
You’ve built up equity in both properties and now wish to buy a third investment property, Property C. To fund the purchase of Property C, your lender uses the equity in both Property A and Property B as security for the new loan. This is an example of cross collateralisation.
Now, all three properties are tied together under one or multiple loans. If you want to sell Property B in the future, you’ll need the lender’s approval, and they may require you to repay a portion of the loan secured by Property C or Property A.
Conclusion
Cross collateralisation can offer benefits, such as leveraging the equity across multiple properties, but it comes with significant disadvantages, including a lack of flexibility, higher risks, and more complex loan management. If you find yourself in a cross collateralisation arrangement, it’s worth considering ways to remove it to regain better control over your property investments.
To better understand how your loan structure may affect your future plans, use this loan calculator and explore ways to optimise your mortgage setup. Or, consult Alegio Partners for expert advice on managing your investment loans.
