For those of you who are unaware of the meaning of ‘cross-securitisation’, allow us to explain. Cross-securitisation or cross-collateralisation is when a lender uses collateral from one or more loans to secure another loan. This is a common technique used by new property investors. Using methods like this to secure loans is a very dangerous game and can mislead a lot of investors into thinking they are safe. Sadly, when problems arise it’s often too late for them to do anything.
This is the primary reason why it’s so hard to inform first-time investors that the way they structure their loans from the start will have will an impact later down the line. New investors would only need 5 minutes in a room with another property investor who has fallen victim to cross-securitisation to know the problems it will inevitability cause.
How does cross-securitisation work?
Let’s start off by providing an example of a typical cross-securitisation loan. Bob is an investor who has just bought his first investment property. He has managed to get an investment loan that is backed by his home and his new wonderful investment property. Bob’s new investment property is worth $500,000 and his loan structure looks like this:
- $250,000 home loan that is secured against Bob’s family home
- $500,000 loan that is secured by Bob’s home and his new property
This is cross-securitisation. When a loan is secured by more than one property (in this case Bob’s home and investment property).
The problems utilising cross-securitisation
There are several problems that arise when investors opt to use cross-securitisation, such as:
Costs: Going down the cross-securitisation route can result in investors paying more for valuation and variations fees. So many investors opt to use portfolio based loans that allow them to separate sub-loans accounts with relative ease. The fall back is these loans are all grouped together and cross-securitised.
Let me paint you a picture, Bob has two investment properties and one family home, he now wants to increase the loan of one his sub-accounts. For this to happen, Bob’s lender must evaluate all of his properties as his loan is cross-secured. As a result, Bob has to pay more in fees. These costs could easily have been avoided if he secured each loan individually.
Lack of options: Using the cross-securitisation approach can potentially tie investors hands when better deals flood the market. Take the example of our friend Bob. His current loan is at a variable rate but recently several really attractive fixed-rate loans have cropped up in the market. As Bob’s loans are cross-secured, he only has the following options:
- To accept the fixed-rate loan that his current lender offers
- Go ahead and refinance his loans to the lender offering the best fixed-rates
- Reorganise his current loan and then refinance a percentage of his investment loan to another lender
As you can see, none of these options are favourable because they all involve fees, a lot of paperwork, or force Bob to switch to a fixed-rate loan with his current lender, who may not be offering the best value.
Less bargaining power: Cross-securitisation also affects investors ability to negotiate. If they want to change a part of their loan or go elsewhere, they have to pay fees. Common issues investors face are:
- Fees for changing loan types
- Offering more security than needed to secure the loan
- Problems and paperwork involved when selling a property
- Higher costs for valuations and variations
- Badly structured loans often result in refinancing to a new lender, lenders know the costs and headache involved for you so have no incentive to reduce their rates to entice you to stay with them.
Benefits: Cross-securitisation isn’t all doom and gloom otherwise nobody would choose this route. They are ideal for:
- Investors who only want to own a single property
- Investors want to lend large amounts ($2 million+) as they will be given as much as 1% discount on their interest rate.
The cardinal rule of cross-securitisation is to avoid this method of structured loans when fixed interest rates are involved. This is due to the costs associated with breaking a fixed-rate loan. Before jumping into a fixed-rate loan, investors should clearly understand what ‘break costs’ are and how much it will cost them if they decide to change their loan in the future. Break costs can go up to the tens of thousands of dollars, the amount varies on a number of factors and time remaining on their loan.
Let’s bring Bob back into the picture, his earlier loan of $500,000 is fixed for five years at 8%. During the second year of his loan, the fixed-rate fees had dropped to 6%. With the equity Bob already has in his home, he thinks now is a great time to buy another investment property. Bob goes to his current lender to work out the details but is rejected due to his serviceability.
Bob goes elsewhere and finds several other lenders who will gladly lend him money who offer even lower rates. Bob is now presented with the following two options:
- Refinance his current loan with a new lender and pay the break costs associated. In Bob’s example above, break fees will be around $40,000.
- Wait until the agreement on his current fixed-rate loan is up, and then refinance to avoid the break costs.
As with before, the two options Bob has are less than desirable. He would never have been in this situation if the loans were not cross-secured, and could have kept his fixed-rate loan with his current lender while refinancing a percentage of his home loan with a new lender.
Offering too much collateral
Offering as little security as possible is best practice when securing any kind of loan, so in the event of a worst case scenario investors end up losing the minimum. In the case of Bob, he has offered his home and investment property as collateral which is quite common with cross-securitisation.
More often than not if the investor has enough equity invested in their home, that will be more than enough collateral to secure a loan. Offering more collateral doesn’t benefit the investor when it comes to tax benefits or offer any other positive incentives. Bear this in mind as it’s all too common to see new investors go above and beyond than what they really need to offer lenders in order to secure loans.
Cross-securitisation can cause havoc when it comes to selling an investment property. Before making a sale on a property, investors must get the consent of their lender. Some lenders may force them to reinvest all money made from the sale to reduce their debt with them, or not allow the sale to go ahead. Now they’re in a position where the lender has control of their actions and what they do with their own money.
Whereas opting for a loan that is standalone enables investors to only repay the remainder of the loan to the lender, and keeping whatever is left.
Good points using cross-securitisation?
As mentioned earlier, cross-securitisation can be ideal for investors with only one property who won’t need to change their lending structure in the future. Even if investors think this to be the case, they still need to proceed with caution. Unforeseen events may occur in the future that may force them to alter their plans. Some investors only ever plan to buy one property but a few years down the line they are looking for more.
For major loans that go into the millions of dollars, opting to go with a cross-securitisation loan can be very beneficial. For loans of this size it’s not uncommon for lenders to off higher discount rates, and sometimes the potential savings are worth the risk.
Ways to avoid cross-securitisation
The easiest way to avoid cross-securitisation is to first obtain a loan that will finance 20% of the property (secured by an existing property), and to set up a separate loan (secured by a different property) to finance the other 80% of the property. Let’s bring Bob back into the picture. His previous loan was using the cross-securitisation structure, his new loan will look like this:
Loan 1 – $100,000 secured by a property he already owns (20%)
Loan 2 – $400,000 secured by his new investment property (80%)
In the example above, Bob will face fewer obstacles if he decides to change lender or invest in more properties. As you can see, each loan is backed by only one property which allows much greater flexibility.
Many investors fall into the trap of not safeguarding themselves for future events or changes in circumstance. They believe the deal they get today is fantastic (and appears so on paper) but fail to look ahead or how markets or their own personal situations may change. Several investors in the past had the mindset of “I will only buy one investment property” or “I have used my bank for decades and never experienced any problems”. Even though both comments may be 100% accurate today, they may not be tomorrow.
There are many problems that come with cross-securitisation that have been addressed in this article, the main problems being expensive costs and inflexibility when investors want to modify their loans. If you have any further questions about whether cross-securitisation is for you, feel free to get in touch with us by giving us a call on 1300 88 73 28 or sending us an email. Our expert team is always on hand to help.
**This information is not intended as advice and should be viewed as general information only.