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Cross Collateralisation, why you should think twice.

Tom and Jane own their house (PPOR), lots of equity in the house. They now want to buy an investment property. They went to their current bank to find out how much they can borrow, and how to borrow. The bank tells them “it is easy, we just use your current home to cover the deposit, one application will do the work”.

Sounds nice and easy, doesn’t it?

Well… No, it’s not.

Tom and Jane need to pause here and investigate what the above suggestion means. Very likely there is a case of cross collateralisation here, see diagram “Cross Colla”. the investment property loan is secured by both their PPOR and the investment property. Not good.

There are lots of reasons NOT to cross collateralise your loans, here are few of them:

1. When you need to release equity from one property, the bank will need to value your whole portfolio, the overall value of the portfolio might not be good enough in bank’s eye, so no equity release. It can take weeks or even months to un cross one property, you might already miss a good purchase opportunity.

2. If you have fixed rate loans in the mix, it can cost an arm and leg to break the cross collateralization.

3. When you sell one investment property to reduce debt and take the profit, the bank again will re value the whole portfolio and may retain big part of the profit if the valuation of the rest of the portfolio does not stack up.

The list goes on…

The better solution is to apply a top up loan (with offset account) secured by their PPOR, then park the cash in the top up loan, use the cash in the offset account to pay the deposit for the investment property, and apply another loan for the balance of the investment property price. This way, the investment property loan is ONLY secured by the investment property. See Diagram “non-cross Colla”

Disclaimer: the above discussion is general in nature, it does not constitute any financial advice or like, please seek your own professional advice for your own circumstances.

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