With so many financing options available to today’s real estate investors, it can be hard to keep up. Cross collateralization, for example, is a financing route that can help investors tap into equity or even finance multiple properties at once. But, what is cross collateralization? Better yet, how does it work? Read through the following guide for a full breakdown of cross collateral loans and find out how (and when) to make them work for you.
What is Cross Collateralization?
Cross collateralization is a process where borrowers either use one asset to back up multiple loans; or they use multiple assets to back up one or more loans. The first option involves using one asset, let’s say a piece of real estate, as collateral for more than one loan. A great example of this is when homeowners take out a second mortgage. Because both loans are secured by the same house, that property would be the one at risk if the homeowner were to fall behind on either mortgage.
Another way to utilize cross collateralization is by securing a loan (or multiple loans) with multiple assets, such as a blanket mortgage. This set up typically happens when investors use the same lender for multiple loans. The lender can then aggregate all of the assets to collateralize multiple loans at once. For investors, this form of cross collateralized loan is typically used to finance multi property deals.
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Pros of Cross Collateralization
There are a few reasons investors might consider cross collateralization. To begin: cross collateral loans can provide financing for those who otherwise cannot get approved for a loan. If an investor has less than stellar credit, for example, but equity built up in an asset, a lender may be more comfortable approving them for a cross collateral loan. Borrowers may also find cross collateralization loans to have better interest rates—as they are essentially trading assets for a loan.
Along the same lines, cross collateralization can allow investors to more effectively leverage their existing assets. Homeowners who are just starting to build a real estate portfolio may find it helpful to use the equity from their first property to purchase a second property. In this case a cross collateralization mortgage could enable them to do so. Even for more seasoned investors this is a major benefit of collatorization, as they can use equity to finance multiple deals at once.
Cons of Cross Collateralization
With any loan type, there are potential risks to consider before moving forward. Perhaps the biggest threat when working with cross collateralization is the potential to lose one or more assets after falling behind on payments.
Essentially, by using the same asset to back up multiple loans, investors increase the number of payments they are responsible for in order to keep that one asset. If homeowners opt for a cross collateralized mortgage, they will then be at risk of foreclosure on their primary residence if they were to fall behind on either loan.
For those who use multiple assets to secure one or more loans, the stakes are even higher. Fall behind on any payments and you could be at risk of losing a bigger chunk of your portfolio. The obvious answer to this is to stay on top of loan payments, but unfortunately that is not always possible.
Investors considering cross collateral loans should always walk through “what if” scenarios to ensure they know what steps to take if a deal does not go according to plan. Remember, if you take the steps to prepare beforehand, you can help avoid the potential cons of cross collateralization.
The Truth About Cross Collateral Loans
Cross collateral loans are not a common financing option, but in some cases, they can be very helpful. Investors who are struggling to find favorable financing options may see that cross collateralization allows them to continue to build a portfolio. Similarly, homeowners interested in passive income investing may be interested in a cross collateral loan to obtain financing for a second property. Despite certain risks being involved, there are situations that warrant cross collateralization. The best way to think about collateralization is dipping into a savings account. While the capital is there (in the form of equity), it may not be the most ideal setup should unexpected circumstances arise.
Depending on the circumstances, cross collateral loans can provide investors the opportunity to leverage their existing assets, tap into equity, and potentially finance multiple deals at once. On the other hand, they can put investors at risk of falling behind on payments or losing multiple assets at once. Ultimately, the decision to use cross collateralization should be based on the situation at hand. At the very least, this financing option should be added to every investor’s repertoire. You never know when it might be the right choice for you.
Have you ever worked with cross collateralization mortgage loans? Share your experience in the comments below.