Cross Collateralization Caveat Emptor
With the tightening Home Loan credit conditions in Australia, Leading Melbourne Mortgage Broker What If We Finance has seen an increase in banks attempting Cross Collateralize securities.
Cross collateralize occurs when more than one property is used as security to support a loan. Melbourne Mortgage Broker What If We Finance says "Cross Collateralization is often asked for the by bank in Property Investment scenarios and if possible should be avoided."
Typically in a Cross Collateralization scenario you have an existing property and wish to buy an Investment Property. In this instance the bank would ask for both properties as security. Leading Melbourne Mortgage Broker What If We Finance CEO Spiro Kolokithas says "in this situation the bank wins because they have both properties securing the Home Loan and in the event of default or bankruptcy the bank has more security than it requires. This is a win win for the bank."
A number of scenarios where Cross Collateralisation is an option are outlined below along with strategies to avoid cross collateralization.
Scenario 1- You have a property with significant equity but do not have enough cash to fund the deposit for the next property. Possible solutions include:
1. Borrow money using the first property as security. You now have funds to buy the property and the second house cannot be repossessed if you cannot pay the loan.
2. Use both properties as security. This is cross collateralization and if you default you can lose both properties. This should be avoided.
Scenario 2 - You have significant cash available and want to fund the next property investment. Possible solutions include:
1. Use the cash to purchase the next property. While it does not cost you interest this may not be tax effective and you may not be maximizing Negative Gearing benefits and you avoid Cross Collateralization.
2. If the first property is your principal place of residence then interest is not tax deductible. In this instance use the cash to pay down the debt on this house and maximize your borrowings on your investment property. In this instance you maximize the Negative Gearing and associated tax benefits. You should also not cross collateralize the securities.
As a Property Investor you can see that some complex situations arise when Cross Collateralization comes in to play. Contact your Mortgage Broker for further advice as each situation is different.