What Is Cross-Collateralization and How Can It Help Investors?
Why it is smart to start investing in the stock market?
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Should I be a trader to invest in the stock market?
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What app should I use to invest in the stock market?
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Is it risky to invest in the stock market? If so, how much?
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Tell us if you are already investing in the stock market
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The simple definition of cross-collateralization is when an asset (in this case, real estate) is used to secure multiple loans. For example, you have a primary residence with a mortgage but take out further borrowing that draws on the equity built up in the home.
The property now serves as collateral for two loans—the initial mortgage and the secondary borrowing.
It’s also possible to use multiple properties to secure a larger loan, something that investors with a more extensive portfolio can take advantage of.
Using cross-collateralization for real estate is a viable method of property financing for those with significant equity. However, before you jump into such a financing deal, it’s vital to have a decent understanding of what you’re signing up to.
The most important thing to know is:
With an asset that secures funding from multiple lenders (or more than one agreement with the same lender), a default on just one of the loans can be considered a default on them all.
This can result in lenders forcing you to liquidate the property to pay off the entire debt.
Each loan will have its own terms and conditions and it’s really important to read and understand the small print of each.
Using Cross-Collateralization for Real Estate Purchases
While any asset can be brought into the cross-collateralization mix, with real estate it’s about leveraging equity in existing bricks and mortar to increase your portfolio. For example, you might already have one or more successful BRRRR under your belt. The collateral you’ve built up from these could be used for an additional property purchase. The advantages of this type of funding include:
Potentially lower interest rates: Secured loans typically have lower rates than unsecured ones.
Reduces or negates the need for a down payment: Making it a viable method of buying your next property without a cash lump sum.
Can be a relatively fast process: This is especially relevant if you’re borrowing from the same lender or a private/hard money lender. When trying to snap up an investment opportunity, speed is often of the essence…
Lenders like cross-collateralization: Because they know they can easily recoup their losses should you default on any of the loans.
Beware the Pitfalls…
It’s essential to have a clear financial understanding before heading down the cross-collateralization route. Such real estate loan structures can differ dramatically between lenders. So, tedious as it might be, having a clear understanding of the finer details is crucial.
The downsides of using cross-collateralization for investment property financing include:
Defaulting on one loan potentially equals defaulting on them all: This applies to whether the borrowing is with a single lender or more than one. Even a single monthly missed payment could trigger foreclosure to repay all the debts.
Your overall risk increases: Each loan reduces the flexibility you have to dispose of your asset/s. While most lenders will be favorable to you needing to sell one of the properties tied to the loan (with a pre-agreed release fee), your options do become more limited.
Because of this, leveraging the power of cross-collateralization should only be considered if a) you have a strong understanding of the financial implications and b) you have a decent buffer in place and no risk of defaulting.
For some, investing in additional real estate through cross-collateralization can be a great way to increase your suite of properties. Such loans are offered by banks and traditional lenders, as well as through hard money/private lenders.
You can even use cross-collateralization to fund additional rehabbing costs on your latest fixer-upper. As many a property investor has found out, even the most carefully calculated costs can often spiral upwards. Using equity in another property could be the answer for a quick, short-term cash injection. As long as you—the borrower—are confident in your ability to meet every monthly repayment, cross-collateralization can be an effective method of exploiting the capital that’s building up in your bricks-and-mortar investments.
BRRRR Loans specializes in creative financial lending designed to help real estate investors reach their goals. Whether it’s cross-collateralization, a fix & flip, BRRRR, or another real estate loan structure, we could be the solution you need.