Cross collateral loans are used by many investors and property buyers, increasing their chances of loan approval while enhancing the terms. They come with inherent risks, but “cross collateralization” also has many benefits.
They may not be for all property buyers, but everyone should, at the very least, understand the advantages and downsides of cross collateral loans.
What are Cross Collateral Loans?
The term “collateral” refers to any type of asset that is accepted by the lender as security against the loan. In the event that a borrower is unable to repay the loan, the bank or lender maintains the right to seize whatever property has been offered and accepted as collateral.
For most loans, the collateral is simple. With an auto loan, the vehicle is collateral; if the borrower doesn’t make payments, the lender can eventually repossess the car or truck, which act as “collateral” on the loan. The same goes for a mortgage loan: the house is collateral; if the lender doesn’t receive payment, they can take possession of the home through a foreclosure.
However, lending is not always a one-asset-for-one-loan situation. With cross collateralization, various assets can be used to secure a variety of different loans. Usually they fall into two types…
A Single Asset Securing Multiple Loans
Cross collateral loans can include a single asset used to secure multiple loans. For example, suppose you have a primary residence with a mortgage, and you currently have 50% equity on the property. You could use this home as collateral for the purchase of a vacation home. In this case, your primary residence is collateral on both the first loan and the loan for the vacation home.
Multiple Assets for a Single Loan
There is also a situation where multiple assets can be used to secure a single loan. This is usually the case when a borrower has multiple loans with the same lender or credit union.
Let’s look at the above example again. In this case, the primary residence and vacation property are used to secure the financing for the purchase of the vacation property. The loan for the vacation property was secured with two assets. Both properties are collateral, and both could potentially be seized if the borrower is unable to pay the vacation-home loan.
Common Types of Cross Collateral Loans
There are a variety of uses for cross collateral loans, and while specific can vary by lender, some examples include…
Investment Loans
Cross collateralization is often used for the purchase of an investment property. In many cases, someone will place their personal property as collateral against a loan that will finance the purchase of a rental property, such as a duplex, single-family home, or even a commercial property.
Vacation Homes
If you are looking to purchase a vacation home, but are having trouble getting decent terms, placing your home as collateral could help.
Blanket Loans
Another example of a cross collateral loan is a blanket loan. Basically, if an investor uses the same lender for multiple loans, the lender lumps all of the assets into collateral for multiple loans.
Advantages of Using Cross Collateral
Helps Chances of Approval
The main benefit of using cross collateral loans is that it increases your overall chances of approval. Lenders can be very meticulous about who qualifies for certain loans, especially on high-risk properties like vacation homes and investments. By bringing more collateral to the bargaining table, you reduce the lender’s overall risk, which will inevitably increase your chances of approval. The more collateral there is on a loan, especially in comparison to the total loan price, the greater your chances of final approval.
High Loan Limit
If you are looking at purchasing a particularly expensive property, using cross collateral could help with your approval. Cross collateral loans could allow you to purchase a large, more luxurious, more in-demand property.
Potentially Allows for Lower Downpayments
The downpayment can be one of the most difficult hurdles to overcome, especially for loans on secondary properties or investment properties, which may require large downpayments. If you use a high-value asset, such as your home, as collateral, the lender may be willing to reduce their downpayment requirements.
Could Help Overcome Credit Issues
If you are seeking a property but are having trouble with credit issues, cross collateral could help. Basically, a credit score is a statement of risk, but having more collateral on the loan reduces the lender’s overall risk, potentially moving you from rejection to approval.
Cross Collateral: What are the Downsides?
Like any loan option, you have to weigh the positives and negatives of using cross collateral loans. And as you’ll see, these can be one of the riskier forms of financing and should be used with caution.
Potential Loss of Asset
The largest downside to using a cross collateral loan for your purchase is that you have a real chance (however small that chance may be) of losing the property you used as collateral. So if you chose to use your family’s home as collateral for an investment, and you fail to make payments on the new loan, you could lose your house. Staying current on the loan is vastly important, as you don’t want to lose whatever asset you placed as collateral.
Limits Ability to Sell Asset
If you use property as a collateral for a loan, it is now tied to the loan and cannot be placed for sale. This is common when vehicles are used as cross collateral: if a car is used as collateral on another loan, say a boat loan, you can’t sell the car because the bank holds rights to it. If you used cross collateral loans for a real estate transaction, it also means that if you want to move, it can create complexities for selling the property, as it is connected to another loan.
See If Cross Collateral Loans are Right for You
Despite the potential risks, cross collateral loans could be useful for investors and people who want to purchase a vacation property. By increasing your chances of approval, and potentially enhancing your terms, cross collateral may be right for you.
Contact us today and learn more about the benefits and risks of cross collateral loans.
