What is cross-collateralisation?

Why are cross-collateralised loans a problem for your portfolio?

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The team at Money Empire have been noticing a growing trend in the mortgage space recently – an increase in cross-collateralised loans. But what are they?

To unravel this concept, we spoke to Money Empire Manager Kayne Wahlstrom and Registered Financial Adviser Goran Loncar.

What is cross-collateralisation?

Cross-collateralisation occurs when multiple properties are used together as security for a loan from one bank.

Cross-collateralisation occurs when multiple properties are used together as security for a loan from one bank. This might sound fine on the surface, but as Kayne explains, problems soon arise when you want to make changes to your portfolio.

"Say someone has two properties with bank A, each worth $500,000 for a total asset value of $1,000,000. They also have $700,000 worth of debt. They want to sell a house to realise some capital for a business purchase or a bit of extra cash. They say to themselves, "we're going to sell house B for $600,000, get $300,000 in our back pocket and leave the debt against the other house. But in the time since they first took out the loans, their income has dropped and they now can't service the debt if they sell a property. They think they'll be getting a healthy cash boost but the bank is going to say "No – you need to use those funds to pay down your mortgage debt"

This doesn't mean, however, that you can't use multiple properties to secure multiple loans – you just need to approach it in a different way.

"Suppose a client has property A with bank A and they have equity in that property they want to buy property B with. We get a revolving credit or overdraft undrawn on property A, and that becomes the deposit for Property B, which is then purchased with a separate bank."

Cross-collartorilised loans are becoming more and more common.Cross-collateralised loans are becoming more and more common.

The advantage of having each property be security for only one loan is that it's clear to you how much debt you have on each asset.

"If you then go on to sell one of those properties, you know exactly how much cash you'll realise once the agent's fees and mortgage has been paid."

As Goran succinctly put it: "Property investing 101 is to spread your risk." Having all of your loans secured with one giant aggregated asset is going to lock you into using a single bank, as well as unnecessarily tie all of your property investment's fortunes.

What can you do if your loans are cross-collateralised?

If your loans are cross-collateralised at the moment, how can the team at Money Empire help you out of that situation? Kayne explained it would start with an analysis of your current position.

"We would look at your portfolio – total assets, total liabilities. We'd then determine what each individual property's worth is and start splitting your risk across different banks."

The advantage of working with financial advisers is that they're an independent party – they're not selling loans, so they're able to give objective advice on what's best for your wallet. As Goran explained: "Often your bank is going to be a first port of call for financial needs, but it's important to remember that they're in the business of making money – they're not going to say, 'for your long term financial health, we'd recommend you get a loan at another bank'." An independent financial adviser, on the other hand, can be trusted to put your best financial interests at heart.

To learn more about working with the Money Empire team for your Auckland financial advice, get in touch today.

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