I have been asked recently, what does it mean to have your properties to be cross collateralised? This term is not a new term. I will try and explain it in the most simplest way possible.
In this article, I am only talking about Cross Collateralising Properties. In general terms so long as there is a tangible value to an asset, like properties, and established businesses, lenders may allow these assets (case by case basis) to be Cross Collateralised.
Cross Collateralised can only occur if you have 2 more more properties. Cross Collateralised Properties in general terms is linking properties into ONE mortgage document. There are benefits in cross collateralising your properties, they are:
Utilising equity in your existing property to secure another property.
This strategy in effect creates a 100% borrowing capacity so long as you have sufficient equity in your existing property to do so. Please speak to your financial planner or tax accountant to understand further in regards to your tax position in utilising this strategy. In this example, it will be assumed that the borrower has the capacity to service the debt and therefore servicing will not be cover in this article. The example starts with a borrower who currently owns a property say with a Market Value of $800,000. Current debt on the property is approximately $500,000. This equates to a 62.50% LVR and $160,000 in equity (80% LVR - $800,000 x 80% -$500,000). So long as you can service the debts, you should be able to borrow up to 80% LVR without the need to pay mortgage insurance.
With this equity, the borrower can now purchase a property up to the value of $800,000 without paying mortgage insurance. To work this out, long form,
Property 1 $ 800,000
Property 2 $ 800,000
Total properties $1,600,000
Max LVR 80%
Max borrowing on properties based on 80% LVR $1,280,000
Equity not borrowed $ 320,000
Total $1,600,000
NOTE: other soft costs are not cover here and it is assumed that the borrower has funds to cover them.
As mentioned before one of the main reasons for doing this is to "tap" equity in your existing property and using this same equity to purchase another property at 100%.
Crossing Properties not belong to different borrowers
Another common reason for Cross Collateralised Properties is when the borrowers were to enter into a borrowing relationship with properties in their respective names. For example, borrower A has a $600,000 property with debts of $300,000, which means, that the current LVR is 50% with $180,000 equity (80% LVR - $600,000 x 80% - $300,000) and borrower B has a $500,000 property with debts of $350,000, current LVR is 70% with $50,000 equity(80% LVR - $500,000 x 80% - $350,000).
If both borrowers wanted to borrower an additional $225,000, borrower A might be able to by paying mortgage insurance however borrower B will not be able to as it will be a negative equity. (NOTE: this does not take into consideration of servicing or the ability to provide commercial facilities). Thus by Cross Collateralising both of their properties, their combined borrowings and also the new debt will fall under 80% LVR and therefore they will not have to pay for mortgage insurance.
NOTE: in this example, it is assumed that the lender is the same for both borrowers. This will not work if the lender are from 2 different lenders.
Selling a Cross Collateralised Property
We have talked about a couple of benefits, here is one main reason why having properties Cross Collateralised may cause problems. Whatever the reason is, there will be a time when one might want to sell their property. If this property is Cross Collateralised, the lender will need to ensure that their exposure to the existing debts can be sufficiently covered by the existing security (property) that is not going to be discharged. If this debt cannot be comfortably covered by the remaining property then the bank may not allow the property to be sold until the debt is paid down to a comfortable level which the lender will be happy to release the property.
4 comments:
300k equity only allows 1.2m in borrowings at 80% LVR so total properties should be 1.5m without insurance. So in the above example, an investor can borrow a maximum of 700k if the property's bank valuation is 700k or more.
Hi David,
$300k equity means that you are already at 80% LVR if the properties are valued at $1.5 Mil. So you will not be able to borrow an additional $ 1.2 Mil.
Another way of looking at it is that if your total debts does not exceeds the 80% LVR ratio then, your borrowings could be up to $1.2 Mill less any outstanding debts. This will ensure that the 80% LVR is preserved.
Not sure about the $700k example. Look at the aggregated view point. If the total properties are x and you want to maintain an 80% LVR ratio then the combined properties of x multiple by 80% will give you the maximum borrowings for this scenario. So the borrowings will be x multiple by 80% less any outstanding property debts.
NOTE: this is a simple property deal and does not involve commercial or personal debts. The borrowing position may change if these variables are added to the scenario.
Regards,
EJ
"a borrower who currently owns a property say with a Market Value of $800,000. Current debt on the property is approximately $500,000"
From the fundamental accounting equation:
Assets = Liabilities + Proprietorship (aka Equity)
Therefore:
--------------------------
Before Cross Collateralised Position:
A = L + P
P = A - L
= 800,000 - 500,000
= 300,000
LVR = L/A
= 500,000/800,000
= 62.5%
-----------------------------------
After Cross Collateralised Position
Equity does not change so
P = 300,000
To determine the value of the second home (A2).
A = L + P
A1 + A2 = L1 + L2 + P (eq1),
Where A = A1 + A2 (eq2)
and L = L1 + L2 (eq3)
New LVR = 80%
0.8 = L/A
0.8A = L
Substitute with eq2 and eq3
0.8(A1 + A2) = L1 + L2 (eq4)
Subtract eq4 from eq1
0.2(A1 + A2) = P
0.2(800,000 + A2 ) = 300,000
A2 = 300,000/0.2 - 800,000
A2 = 700,000
Therefore second home should be valued at 700k making portfolio valued at 1.5m.
Loan1 and Loan2 total should be 1.2m. Loan1 should be increased from 500k to 640k and Loan2 should be 560k.
Don't know why you'd bother cross collateralising. This example can be achieved by refinancing and using different lenders. Why give one lender powers to sell both assets if only one of the mortgages is in arrears?
Yes I see you calculation and it is sound. This example will allow the borrower to have both property under different loans (in effect different lenders).
However given that there is equity of $300k from property one and the borrower wanted to purchase a $1.5 Mil property and have the loan set at $1.5 Mil for Tax Advantage reasons, then the borrower will have to Cross Collateralise both properties.
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