Should you cross collateralise your assets to purchase investment property
On the face of it the idea of cross collateralising your assets to purchase investment property seems to be a good idea. In many cases to this will make it cheaper for you to set up a mortgage on an investment property where you will be using the equity in another property as the ‘deposit’ for the purchase.
Saving money seems to be a great idea, but unfortunately this time it is probably not in your best interest.
Cross collateralising is something that many new investors allow themselves to get ‘talked into’ because of the cost saving factor, but the only winner is the lending institution.
Take a long hard look at this scenario (this is purely an example only)
If you own a $600,000 home with $450,000 equity (loan $150,000) and you decide to purchase an investment property of $300,000 you will need $60,000 ‘deposit’ from the equity and borrow a further $240,000. That looks good as there is the equity in the home so you go ahead and set up your mortgage structure to include both properties. In total you will now have a loan worth $450,000
A few years down the track you decide you want to sell your home. What happens:
- your house is sold for $750,000
- you have an approximate loan worth $430,000 over both properties (after 2 years)
- the investment property part of the loan is $290,000
What is going to happen here with a cross collateralised loan is that the lending institution will want the $290,000 paid out of the cash from the house to release the mortgage. That then would mean that your investment property is freehold and worth nothing to you as an investment to use against taxes. This would mean that you would then be paying tax on income from it.
Not only that, you are only going to have cash in hand of $320,000 (no expenses included for the same of the example) after the mortgage has been paid out and a free hold investment property.
If each property had been set up separately
Whereas if the investment property had been set up as a stand along mortgage then the loan on the home would have been $150,000 + $60,000 = $210,000, less any repayments off capital, say $10,000. This would give cash in hand after sale before sale expenses of $590,000. Plus you would own an investment property with a full mortgage.
It would be quite probably that you would need to pay some monies towards the mortgage on the investment property to satisfy the bank, but the property would most likely have gone up in valuation and so there is a chance you may not have to, but just readjust some paperwork at the bank.
Set up separate loans
When first starting out with property investing, it is a good idea to mortgage each property separately. This may mean you need to take on another mortgage to free up the equity in a property for the deposit, but at least each property will not be affected by the other if you wish to sell.
As you build up your portfolio you will be able to change your finance structures, but initially it pays to keep each property separated.
Read our article on Private Lending. Although this particular article was written for those wishing to flip houses, it is also good for investors who may want to sell after a few years because as described private lenders are often keen to leave their money with the same investor if there are no problems.
The thing is, a similar situation could exist here if you borrow for a business or any other type of asset, so it is always worth looking at all aspects of the loan if you are going to cross collateralise.
Filed Under: Property Investment Tips
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