This strategy could affect your long-term property investment goals
Cross-collateralisation: the word alone is enough to send property investors running to the hills.
However, those who are more seasoned recognise the potential advantages of the cross-securitisation strategy, particularly when it comes to tax benefits.
There’s an argument for both sides but it depends on how big you plan to grow your investment portfolio.
How do I qualify?
The property securing the loan must be common to all loans under the cross-collateralised structure.
Each mortgagor under the cross-collateralised structure must be either a debtor or guarantor.
Any guarantor on any loan within the cross-collateralised structure will be required to guarantee all loans within the cross-collateralised structure.
In the case of a third party loan where a borrower is not a mortgagor, that borrower must have a direct relationship to a mortgagor, with respect to control such as through a company structure, where a mortgagor is a director.
You must stay within the bank’s mortgage exposure limits.
Which lenders will allow you to do this?
The more you cross-securitise, the more your borrowing power becomes tighter.
In recent times, the industry regulator, the Australian Prudential Regulation Authority (APRA), has forced banks to tighten their policies on investment lending.
What this has meant is tighter mortgage exposure limits, requiring you to provide more security in the form of equity or a deposit that you’ve saved yourself.
There’s no telling how long banks will allow you to cross-collateralise!
Please call us on 1300 889 743 or fill in our online enquiry form to speak with one of our mortgage brokers about your investment plans.
What is cross-collateralisation?
This is where more than one property is used as security for a mortgage rather than a standard home loan where you have one property securing one mortgage.
How most property investors start is by buying an owner occupied property and building equity by paying down the loan and through market growth.
When your Loan to Value Ratio (LVR) gets to below 80%, most lenders will allow you to access your equity, which you can use to purchase a new property instead of having to save up a deposit.
For example, let’s say your home is worth $800,000 and you have $400,000 owing on the home loan.
That means you have an LVR of 50% so you can access up to 80% of the property value of available equity.
In this case, you have 30% of the property value to use as equity or $240,000 (although banks rarely allow you to borrow up to your limit).
You could buy an apartment unit in Adelaide worth $190,000 at 100% of the value, secured on your mortgage and get cash out of $10,000 to add to your offset account.
In this example, both properties are secured by your mortgage, which is now $600,000 ($400,000 initial home loan + $190,000 for the unit + $10,000 cash out).
This brings your property portfolio is now worth $990,000 and your combined LVR to just over 60%.
Some investors choose to continue with this strategy until they build a large portfolio.
This is in contrast to the more complex approach of having multiple loans secured by multiple properties with potentially multiple lenders.
Note: This example doesn’t take into account the cost of stamp duty, bank fees and legal costs associated with purchasing a property.
The benefits of cross-securitisation
Generally speaking, cross-collateralising makes sense when you’re just starting to build your portfolio.
Specifically, it’s for people who don’t plan to sell any of their properties soon (at least 10 years or so) and don’t plan on buying more properties in the near future.
You can get a lower interest rate
One of the main advantages of this strategy is getting a much lower owner occupied interest rate on your whole portfolio as opposed to a high investment loan rate.
That’s because some lenders will allow you to use you owner occupied property and cross-securitise it with your investment properties.
The difference between paying something like 3.80% with a home loan rate and 4.20% with a investment loan may not sound like much but it is!
For example, if you have $200,000 owing on your $800,000 home at 3.80% p.a., your total repayments over 30 years will be $335,490.
If you were to buy an investment property worth the same as your current mortgage ($200,000) at 4.20% p.a., your total repayments would $352,093, or more that $16,500 over 30 years.
Greater tax benefits
Even though you’re cross-collateralised with an owner-occupied loan, you may be able to claim tax deductions on your investment properties.
In fact, because you’re using equity to purchase an investment property at 100% of the value, your purchase is potentially 100% tax deductible.
Compare this to getting a 90% investment loan where you’re missing out on these extra deductions because you partially-secured the loan with your own funds (savings).
It’s best to consult a qualified accountant about what options may be available to you.
Check out our guide on depreciation for a property for some more tips.
It’s a good strategy when downsizing
Many people buy an investment property with the intention of downsizing to it after selling their own home.
Having both properties under the same mortgage with the same lender makes it easier to manage for people who don’t have big investment plans.
By holding the investment property for a few years, you should have enough equity to uncross-collateralise even based on conservative property growth estimates.
What are the drawbacks?
Despite the positives, cross-collateralisation can get very messy, very quickly.
Untangling this mess can turn into a nightmare because you just don’t get the same flexibility as having separate investment loans.
Market downturns can be devastating
This is where cross-collateralising can be a death knell to your investment plans.
Most investors are weary of avoiding concentration risk or not “putting all of their eggs in one basket” when it comes to choosing property locations.
However, even if most of your properties have enjoyed a capital gain, a significant drop in value with just one of your properties could see the net effect on your total portfolio value reach zero.
That’s because the properties are linked.
The equity in the property that increased in value can’t be accessed because the overall equity in the portfolio didn’t increase.
For example, property prices have dropped considerably in mining towns that have seen significant economic deflation, most notably in Western Australia.
Banks can get power over your home
If you can’t pay your home loan, the bank can decide where the proceeds of a sale are allocated on your cross-securitised mortgage.
They can pretty much tell you what loan to pay, how much and when in order to keep the LVR within their acceptable level, usually at 80% of the property value or lower.
This could potentially mean they can force you to sell your own home rather than one of your investment properties.
If you already have a few properties in your portfolio, call us on 1300 889 743 or complete our free assessment form.
We can provide a “health check” of you current mortgage strategy and whether it will continue to support your investment goals going forward.
All properties need to be revalued when refinancing
If you want to refinance to drawdown equity, get a better interest rate or simply switch home loan packages with your bank, all properties will need to be revalued.
First of all, this can come at a significant cost depending on how many properties are cross-securitised.
Secondly, the process can be complicated and time consuming as banks have to order a Variation of Security.
It’s ok if you’re not in a rush to settle on your new property.
The much bigger risk is that the valuer could come back with a low valuation, preventing you from refinancing.
Switching to a new lender can be tough
Planning to refinance your portfolio with another lender?
Perhaps the lender is offering a better interest rate or has a higher mortgage exposure limit.
The problem is that each lender has different lending policies and may not accept:
- Aspects of your financial situation such as if you’re self employed.
- The LVR of your portfolio.
- The types of properties in your portfolio such as inner city units.
The bank may restrict you to P&I repayments
As your mortgage exposure with one bank increases, you’ll be restricted to certain loan types such as making principal and interest (P&I) repayments instead of interest only.
If P&I doesn’t form part of your current strategy, it may not be a good idea to add another property to your portfolio until you’re able to pay down your LVR to around 50-60% and build up your savings.
Because of this, investors with long-term investment plans may find using multiple lenders a better option than cross-securitising.
Is cross-collateralisation right for you?
If you can avoid cross-securitising, it’s usually the better option.
However, let’s say you’re not in a hurry to move your portfolio around and your LVR is at around 50-60% of the total portfolio value.
Cross-collateralisation may be a good option in order to score a sharper owner-occupied rate and avoid having to put up your own funds to buy an investment property.
At this LVR, it should also be possible to unlock or decouple your properties if you needed to sell your properties.
Every situation is different!
Speak with a mortgage broker about the options available to you.
Call us on 1300 889 743 or complete our free assessment form today.