Loan structure mistakes: What is cross collateralisation?

A common loan structure that often causes problems down the line is cross collateralisation of your loans.  A cross collateralised loan breaks the principles of good loan structuring by having 1 loan against 2 securities.  You can only be cross securitised if you own multiple assets with the same bank.

Cross securitization means that you lose flexibility and control. Any decision on one of your loans is interdependent on what is happening with the other.

You may lose the ability to draw out equity: because both securities are linked, you can no longer value one of those securities in isolation – you will need to value both.

So let’s work through the key issues with cross collateralisation – why does it happen? Why should you avoid it? and how do you find out if your existing loans are crossed?

Why does cross collateralisation occur?

Generally speaking, crossing loans will put the lender in a stronger position than if the loans were ‘stand-alone’, even if the total lending and security values are the same.

Further, it flows that if the bank is in a stronger position by crossing the loans, you the borrower are in a weaker positon. Banks will look to cross loans wherever possible, so if you are dealing directly with the bank for your loan you need to be vigilant they don’t slip this into your loan contract!

In addition, banks usually sell the ‘simpleness’ of cross collateralising to consumers.  Cross collateralising your loans usually involves having one large loan for your investment, secured by two properties.  The better set up is to instead have two separate loans, each secured by an individual asset (deposit loan and the investment loan).