The most recent Australian Taxation Office statistics show that there were 2,268,161 property investors in the country in the 2021-22 financial year. Of those, just under 30% owned more than one investment property. Property investors with more than one property can use cross-collateralisation as a means of securing a loan – but what is cross-collateralisation and is it a good idea?
Cross-collateralisation is a financial strategy that involves using multiple properties as security for a single loan. For example, you are an investor who owns the home you live in as well as an investment property. If you would like to take out a mortgage to buy a second investment property, your lender might secure the loan against all three properties. This can simplify loan management but can also present risks for investors.
The pros of cross-collateralisation
Tax benefits
In some cases, cross-collateralisation can offer tax advantages. By using multiple properties to secure a loan, you can increase your borrowing capacity and expand your portfolio with more investment properties. And, because interest payments on loans for investment properties are typically tax-deductible, the more investment properties you have, the less you may be liable for tax as you can reduce your taxable income and increase overall returns.
Equity
Cross-collateralisation can allow you to unlock equity in your existing properties. This allows you to tap into the equity of your entire portfolio without needing to refinance each property individually. For example, if one property has grown significantly in value, you can use the equity in that property to fund further purchases or renovations.
Convenience
Cross-collateralisation simplifies the loan process by consolidating securities under one lender. This could mean you have to deal with fewer applications and see a more streamlined application process, leaving you more time to focus on your investments.
Potentially lower interest rates
When multiple properties are secured under a single loan, lenders may offer more competitive interest rates. The reduced risk for the lender (as they have multiple assets as collateral) can translate into cost savings for the investor.
Cons of cross-collateralisation
Lender is in a strong position
One of the major drawbacks of cross-collateralisation is the increased control it gives to your lender. If you default on one loan, the lender can pursue repayment by selling any of the properties used as security. This could put your entire portfolio at risk.
High costs
To process a loan with cross-collateralisation, lenders often need valuations for all properties concerned. That includes the property being purchased, as well as any you are using as collateral. This process can lead to increase costs. Additionally, valuations are done at the discretion of the lender, which may produce conservative estimates that impact your borrowing potential.
Complications when selling
Cross-collateralisation can make it challenging to sell a property without affecting the remaining loans. If you choose to sell one property, you will need permission from your lender, which can lead to delays. Your lender may also require proceeds from the sale to reduce the loan balance, thereby potentially limiting how much money you have to reinvest.
Is cross-collateralisation right for you?
While cross-collateralisation can help you access new investment opportunities, it is not a one-size-fits-all solution. Investors who are looking for simplicity and have long-term plans for their portfolio might find the process beneficial. But, for those looking for flexibility and the ability to make quick decisions, or those who might want to refinance or sell individual properties in the short term, the risks may outweigh the benefits.