Control.
Some borrowers want more of it and some don’t care for it. Some are not even aware they have options—until too late.
When it comes to collateral for a home loan, the control I am talking about is how (and how many) properties may be secured by a lender when establishing a home loan.
What is cross collateralisation?
In the world of home loans, cross collateralisation is where more than one property is used as security for the same home loan(s).
Securing property as collateral for a home loan provides a lender with ultimate control of the lending arrangement. In an extreme case of default, property can be the central piece for a lender to repossess and recover any monies owed.
Cross collateralisation is a common solution for borrowers looking to use existing equity to buy another property. Instead of using cash as a deposit, homeowners with equity can use their existing property as security—with little or no cash contribution.
Multiple properties sit in the same security bucket when home loans are cross collateralised. This means any lending is dependent on the value of securities—not one or the other.
Banking language will often substitute the terms “collateral” and “security”. So, another term you might see for cross collateralisation is cross securitisation or cross securitise.
How does cross collateralisation work?
The bedrock of residential property lending could be considered the balance of reward with appropriate risks. To reduce risk associated with home loans, lenders can secure these loans by registering an interest in the property (a mortgage). This way the property acts as the primary security (collateral) for the home loan.
In cross collateralisation, instead of one property acting as security for any home loans, two or more properties are used.
Cross collateralisation can be a solution to the popular question from existing homeowners:
How does equity work when buying a second home?
Whether a second purchase is a holiday home or investment property, cross collateralisation follows basic lending principles.
Example of cross collateralisation
An 80% loan to value ratio (LVR) is the commonly accepted gold-standard exposure for lenders in Australia. So, I’ll use that in these scenarios.
When homeowners refer to property equity, they are referring to the difference between the property value and the loan amount owed.
In our example this homeowner demonstrates $500,000 in equity.
Cross collateralisation will introduce another property as additional security. A way to think about this is when a lender combines, or crosses securities, they place the properties in the same bucket. This bucket has a combined value that can secure all loans—new and existing. A cross collateralisation example is below:
A calculation the bank does to assess their exposure to risk is to measure the ratio of loans (new and existing) against the combined value of all properties. In our example, the total loan to value ratio (LVR) is 69% – below the 80% LVR standard.
This example shows how cross collateralisation has enabled the use of existing property equity to borrow $600,000 for a property purchase plus an $30,000 cover costs.
Who benefits from cross collateralisation?
Cross collateralisation works—for the bank. The bank adds another property to its security position which allows it to advance further lending to borrowers.
When multiple properties are cross collateralised, selling a property still leaves the bank with any remaining properties as security. To an extent, these properties give the banks control as their valuations help determine how sale proceeds may be required to pay down loans.
For the most part cross collateralisation works for borrowers too. Borrowers can use existing property equity to enable buying another property with little or no cash contribution.
Some buying scenarios require the use of cross collateralisation as the core lending principle. Bridging loans are a good example of this. They use two properties to help a buyer purchase a property before they have sold their existing home.
How bridging loans differ to a regular cross collateralised loan, is the timeframe for holding two securities is defined, with very clear guidelines and time limits for paying down loans upon sale.
Cross collateralisation pitfalls
Home loans almost always looks good at the outset. Property purchased—a job well done.
In my experience arranging home loans for borrowers, it is along the home loan journey that issues with the initial set-up can arise.
Lenders mortgage insurance
Cross collateralisation can sometimes lead to more expensive lenders mortgage insurance costs compare to an alternative loan structure.
Retention of sales proceeds
Selling should be a straightforward and transactional part of the lending process. But it is often a source of high drama—often not anticipated at loan establishment.
Selling a property can invite a revaluation of any other properties used to secure your lending. I have seen borrowers quite surprised and annoyed to learn banks can request that sales proceeds be committed to reducing loan amounts, rather than be used as surplus funds.
Accessing equity
Cross collateralisation can limit access to equity based on property values. Valuations are usually based on all properties held as security—in the security bucket. So, each property value can affect the overall valuation amount. This in turn affects access to property equity.
Alternative structures offer the borrower more control and flexibility in accessing property equity.
Standalone: An alternative to cross collateralisation
Of particular interest to me over my mortgage broking career was how borrowers can have more control over the loan security arrangements than they might realise.
Avoiding cross collateralisation by adopting a standalone position can offer borrowers the potential to have more flexibility and control over lending strategies.
When one property is acting as the security (or collateral) for one or more home loans, the loan structure is referred to as standalone.
Standalone can be considered an alternative to cross collateralisation.
A standalone arrangement can be beneficial to borrowers at property purchase stage, in the future, or both. It can give a borrower more control over their lending arrangements than a cross collateralised structure.
How does standalone work?
When properties standalone they support loans on their own—not in combination with another property.
Multiple properties are not in the same security bucket for a standalone structure.
The properties are never represented on a loan offer as security together – one property per loan contract.
Let’s explore the same questions we did earlier, with a twist:
How do I use my equity to buy another property—and be standalone?
Here is one way.
Existing property is still needed to support the new purchase. The difference being, only the amount of equity needed from the existing property is used – not the entire property.
Using our example above:
There is $500,000 in property equity but the new purchase does not need all of this.
This standalone example below shows two properties and two loan applications that achieve the required outcome – $630,000 in lending to support the new purchase.
The key being two loans are established, one against each property.
The loan using the “existing property” is arranged for an amount of equity needed. In this case we need to cover enough so the property being purchased can have an 80% LVR—and be standalone. We also need to be mindful that the existing property has loan limits that will remain under 80% LVR.
The amount equity used from the existing property is 20% of the purchase value ($120,000) plus costs ($30,000)—so $150,000. This is one of the loans needed.
The other loan uses the new property for an 80% loan of $480,000.
Both loans are for the same purpose (buying the new property) but are secured against different properties.
The total amount of lending is $630,000 spread across two split home loans, which is enough to cover the purchase price of $600,000 and associated costs, like stamp duty.
In general, a standalone property can result in one more loan as outlined in the transaction above.
Here is where the power of a standalone arrangement lies.
Any request by the borrower that affects the standalone home loan, may result in the lender assessing the value of the standalone security only. This can avoid possible complications that can come with valuing every property in a portfolio—as can be the case in a cross collateralised loan.
Cross collateralisation vs standalone
There are many arguments when it comes to cross collateralisation vs standalone home loans. I summarise a few of them here based on my experience in Australian mortgage broking since 2008.
Aside from buying a property, borrowers can have future home loan needs that centre around making loan changes, selling, investing, growing a portfolio.
Accommodating future lending needs (known and perhaps even unknown) can be nuanced area of lending requiring where experienced lenders and mortgage brokers can be a big help.
Here are some areas where loan structure can have a major impact to borrowers.
Drawbacks of a standalone agreement
For all the flexibility of a standalone home loan structure, there are some drawbacks to be aware of. These can be considered a price to pay for improving control and flexibility around loan structure.
- Borrowers might need to raise the idea at loan application stage as it is not always proposed by a lender. It might take some effort and time to explore if it is suitable or not to your situation.
- More loans can mean more administration for the borrower.
- More loans can attract more fees. However, many lenders can accommodate standalone home loans under one annual package fee.
- Selling a home can require certain loans to close. If any loans are required to stay open (say, for tax reasons) then extra work may be needed at this stage to re-secure a home loan against another property with equity.
- Standalone is not always an option. Banks sometimes request cross collateralisation. I saw this most often when there are business lending arrangements involved.
How do I apply for a standalone home loan?
Mortgage brokers are a great source to consider if a standalone home loan structure is suitable. In part because licensed brokers should be skilled in this area as well as being uniquely positioned to consider more than one lender (if beneficial) when performing their analysis.
Mortgage brokers are also there for the home loan journey and so should consider the borrowers end-game, or exit strategy, when arranging a loan structure.
While a standalone structure is not always necessary, and involves more time, work and effort—I have seen this insulate borrowers from messy situations many times over.
Who does a standalone structure benefit?
There is not simple answer to this, that is why licensed mortgage brokers exist. Different solutions will suit different borrower circumstances.
In my experience, I typically saw investors as the main borrower group to benefit from a standalone home loan.
Accessing property equity is an important strategy for investors. Standalone structures can enable investors access to equity from one particular property while ignoring others. This differs from a cross collateralised loan structure where the sum of all property values is what the lender will rely on when a considering a property equity loan.
A word of caution
Borrowers should go into a standalone agreement with eyes wide open.
There are numerous reasons to seek financial and legal advice around getting the loan structure right in the beginning. I recommend borrowers do so.
If a standalone home loan is a strategy to circumvent a low valuation, borrowers should get appropriate advice around their lending strategy before they continue to leverage against their equity.
There can be very good reasons for a valuation not coming in as expected. This should not be ignored by a borrower. This differs from a lender not recognising true property value that exists—as can be the case with rezoned or subdividable land.
Standalone home loans can give a borrower more control. With control comes responsibility. Borrowers need to exercise appropriate caution around risk-taking for their situation and avoid a situation where they are over-leveraged or in negative equity.
FAQs
I am cross collateralised. Is it too late to change my loan to standalone?
No. But it will depend on the strength of your current financial position.
In some cases, it may be possible to re-arrange cross collateralised lending into a standalone arrangement through a substitution process—thus avoiding a full application.
Otherwise, re-organising your loan structure may require a full application to your existing bank or even a refinance home loan to new lender.
While the level of assessment varies between a substitution and full application, both will likely require new valuations.
You should speak to a mortgage broker to find a solution specific to your situation.
Do I need to be at different banks to avoid cross collateralisation?
No – it is possible to have a standalone structure at the same bank.
Can I have cross collateralisation above 80% LVR?
Yes. It will be subject to eligibility but the principle is the same. I have seen this have the added benefit of reducing the overall LMI fees.
How do I tell if my loans cross collateralised?
If you are wondering if your loans are cross collateralised you can call your lender, mortgage broker, or even look at your original loan offer.
When a cross collateralisation structure has been used, multiple properties should be listed on a loan offer from a lender under the section referencing “security”.
A have a standalone structure can I adjust this?
Provided you are eligible, you can usually change the structure. An example of this could involve consolidating more of your investment debt against the investment property and away from the family home. Like a recalibration.
Final word
The main reason for writing this article is that I found many borrowers during my time in mortgage broking were unaware these options existed.
Some borrowers suited cross collateralised home loans and others saw in standalone arrangements.
When borrowers with multiple properties take out home loans, they should be made aware of the different options to structure their home loans.
Importantly, it might not be too late for a borrower to change loan structures, especially if valuations have improved since last time loans were revisited. There may be cost and eligibility considerations when considering a restructure, but experts can help.
