Cross-Collaterisation - Does it matter?

[seano87]

Hi all,

Up until now, I've been under the assumption that you should not cross colaterise your investment properties, as this would lead to the bank having access to all your properties in the event that you owe the bank more than what they can get for selling the security they hold.

I'm reading a Margret Lomas book at the moment and she states

'It is a false notion that a bank only has the power to take the proceeds of security it directly holds. If you are found to have property elsewhere that may yield funds if sold, then you will be required to sell it, even if it is held by another bank.....
There are other disadvantages with having loans all over the place....If each property you own is held by a different bank, then a single property must increase enough in value to generate a deposit to buy more property without having to re-mortgage the whole package or take some other complicated action. If however, all securities are held with just one bank , then each property only needs to increase a small amount in value to make the total values enough to buy more though one simple loan increase.'

She is a fan of having many sub-accounts on a Line of Credit.

Intersted in the views of investors on here. Is this true? Why do people always stress that you shouldn't cross-colaterise?

Thanks

Sean

 

[alexlee]

If you sell a property and the proceeds aren't enough to repay the mortgage, the bank can and will come after anything else you have, no matter who it's mortgaged with. That's not the real risk of cross col.

The real risk is when you have two properties of 400k each, crosscolled to 80% (640k). You sell one, thinking I'll pay 320k off that and get the rest in cash. The bank says 'actually, we'll only allow 70% LVR now', and you end up with less or nothing from the sale.

Whereas if the two properties were mortgaged with different banks, or at least two separate loans with the same bank at 80% each, this scenario is less likely.

The 'small increases can be used more efficiently' argument is a bit weak. If you need to refinance every 5 or 10k increase, you might as well go for a higher LVR in the first place. If you're already at a high LVR, LMI will kill those small refinances.

I've personally never found refinances to be 'complicated'. That's what my MB is for.

 

[geoffw]

It can be very hard to move if your current bank doesn't want to lend you more, even if you have the equity.

I had a situation where I had to xcoll as the property was excellent- there was no other way of getting a loan for it. (buy price $490K sell price $770k three years later- and a pity we had to sell).

But in the selling and refinancing (required for a business loan) it was a real mess. We had all sorts of hoops to jump through, and new loans to apply for as the bank I was with didn't want to play ball with us any more.

 

[Aaron_C]

X-coll makes it harder for you to move. It's not a problem until it's a problem.

 

[Peter_Tersteeg]

The odds that the bank will take multiple properties that are cross collateralised is extremely low. I don't believe I've ever seen this problem occur.

The problem with cross collateralisation is that you give all control of your finances to the bank. Instead of being a finance provider, they can become a finance dictator! Some examples that I have seen...


I've had a lot of clients preparing for the settlement of a property. The vendors solicitor has delayed the settlement because the vendors bank won't let the vendor release the property. The vendors bank first revalues the entire portfolio to ensure that they've got enough equity to support the remaining loans. If the vendor wasn't cross collateralised, this wouldn't be an issue at all.


Another case, the person was raising cash for a large deal (which was going to make them financially independent). To raise the cash, they looked at their existing portfolio, selected a property that had a lot of equity, but was under performing for cash flow and wasn't expected to have much future capital growth. They sold this property. The bank looked at the rest of their portfolio and told them that instead of taking the cash from the sale the bank wanted them to pay down some of their other loans.

This person had to refinance their entire portfolio to several another lenders who was willing to be more flexible. This took a significant amount of time and it cost substantial $$$ to move. They still got the big deal at the end of the rainbow, but only just.


Cross collateralisation is rarely to your advantage and has a lot of disadvantages. It gives a lot of power to the bank. It's rare that it costs you anything to avoid it other than a small effort and some forward planning. I've written thousands of loans for clients and can only think of a handful of circumstances where it's been to the borrowers advantage to cross collateralise.

I've attached a document describing 10 reasons to avoid cross collateralisation. None of them is about loosing your house.

 

[Terry_w]

'It is a false notion that a bank only has the power to take the proceeds of security it directly holds. If you are found to have property elsewhere that may yield funds if sold, then you will be required to sell it, even if it is held by another bank.....

This is a half truth. True at the end of the 6 to 12 months or so it may take for a bank to get a judgment, but in the meantime not having loans crossed will allow a person great flexibility to sell down properties at their own leisure and choice.

It is bad advice in my opinion.

 

[perthguy]

Intersted in the views of investors on here. Is this true? Why do people always stress that you shouldn't cross-colaterise?

I have cross-collateralised a PPoR with an IP and I would not do it again. It is more expensive to set up in the first place and more expensive to unwind. Most importantly, it limits my options for funding future purchases. A better structure would be to have an independent loan against the PPoR with an offset account. Fund in the offset account can then be used for investing. If the equity in the PPoR increases, the loan can be increased by an appropriate amount. This is the structure I will use once I can get the cross-collateralisation unwound, but the IP has a fixed interest term and I can't un-cross until that expires.

 

[alexlee]

A better structure would be to have an independent loan against the PPoR with an offset account. Fund in the offset account can then be used for investing.

Who gave you that advice?

Withdrawing from a PPOR offset for investment purposes means the interest on that isn't deductible.

 

[jonmardell]

Who gave you that advice?

Withdrawing from a PPOR offset for investment purposes means the interest on that isn't deductible.

unless the offset is linked to a sub loan that was cash out for the investments.

 

[perthguy]

Who gave you that advice?

Withdrawing from a PPOR offset for investment purposes means the interest on that isn't deductible.

The interest on what isn't tax deductible?

 

[alexlee]

The interest on what isn't tax deductible?

Assuming it's NOT jonmardell's scenario.

You take out 300k for a PPOR loan. You have an offset against this loan.

Over a year, you put in $50k from salary, savings, pokie winnings, whatever (other than proceeds from another loan). You pay interest on 250k, none of which is deductible.

You use the 50k to buy an IP.

You now pay interest on 300k of the PPOR loan. NONE of it is deductible.

 

[perthguy]

Assuming it's NOT jonmardell's scenario.

You take out 300k for a PPOR loan. You have an offset against this loan.

Over a year, you put in $50k from salary, savings, pokie winnings, whatever (other than proceeds from another loan). You pay interest on 250k, none of which is deductible.

You use the 50k to buy an IP.

You now pay interest on 300k of the PPOR loan. NONE of it is deductible.

That's an interesting claim. Any supporting evidence? I say the interest on the 50k is tax deductible.

http://www.ato.gov.au/Individuals/I...es/Rental-properties-2012-13/?page=9#Example9

Quote from same page: "In cases of this type, the interest on the loan must be apportioned into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes."

So as long as I apportion the interest into the deductible and non-deductible parts appropriately, I don't see the problem. Of course, it could get pretty ugly if there is balance owing on the PPoR and balance owing on the IP from the same account at the same time. ATO provides the following guidance:

"If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds."

In my case the PPoR loan is fully offset and any funds drawn are solely for the IP. In that case, 100% of the interest is tax deductible.

 

[Brady]

OP long story short don't x-coll if you wish to build a large property portfolio.

There are so many reasons why you shouldn't x-coll and really the benefits of doing it are pretty much none existant in my mind.

 

[Corey Batt]

That's an interesting claim. Any supporting evidence? I say the interest on the 50k is tax deductible.

http://www.ato.gov.au/Individuals/I...es/Rental-properties-2012-13/?page=9#Example9

Quote from same page: "In cases of this type, the interest on the loan must be apportioned into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes."

So as long as I apportion the interest into the deductible and non-deductible parts appropriately, I don't see the problem. Of course, it could get pretty ugly if there is balance owing on the PPoR and balance owing on the IP from the same account at the same time. ATO provides the following guidance:

"If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds."

In my case the PPoR loan is fully offset and any funds drawn are solely for the IP. In that case, 100% of the interest is tax deductible.

Actually Alexlee is right with this one. An offset account is a bank account, not a loan. Taking funds out of this account is not borrowing. Whether the bank wishes to have an arrangement where they don't charge interest related to the balanace of an offset account is irrelevant, as the overall funds are still from a bank deposit, than borrowed funds.

 

[alexlee]

That's an interesting claim. Any supporting evidence?

Yes, provided by the ATO, via yourself:

"If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds."

Look at your loan statements again. With an offset against it, your loan account DOESN'T fluctuate. The balance of the offset account does. Deposits into the offset account are NOT loan repayments, and withdraws from the offset account are NOT new borrowings. So your loan balance always retains its original purpose: used to buy your PPOR and therefore not deductible.

 

[perthguy]

Look at your loan statements again. With an offset against it, your loan account DOESN'T fluctuate. So your loan balance retains its original character: used to buy your PPOR and therefore not deductible.

No, you're right. I forgot the loan against the PPoR was towards an IP, not to buy or pay off the PPoR. The PPoR had no loan at the start. The purpose of the loan was for investments from the start.

 

[Rolf Latham]

Xcoll is a valuable asset

To the lender

Ta

Rolfe

 

[Rolf Latham]

Hi all,

Up until now, I've been under the assumption that you should not cross colaterise your investment properties, as this would lead to the bank having access to all your properties in the event that you owe the bank more than what they can get for selling the security they hold.

I'm reading a Margret Lomas book at the moment and she states

'It is a false notion that a bank only has the power to take the proceeds of security it directly holds. If you are found to have property elsewhere that may yield funds if sold, then you will be required to sell it, even if it is held by another bank.....
There are other disadvantages with having loans all over the place....If each property you own is held by a different bank, then a single property must increase enough in value to generate a deposit to buy more property without having to re-mortgage the whole package or take some other complicated action. If however, all securities are held with just one bank , then each property only needs to increase a small amount in value to make the total values enough to buy more though one simple loan increase.'

She is a fan of having many sub-accounts on a Line of Credit.

Intersted in the views of investors on here. Is this true? Why do people always stress that you shouldn't cross-colaterise?

Thanks

Sean

The stg portfolio product works best and pretty much demands that cross coll is used.

Using any form of lo c as the backbone for your ip financing ignores the perils of this style of product with many lenders

Ta
Rolf

 

[perthguy]

Rules To Keep Your Borrowing Tax Deductible
1) What the borrowed money is used to buy determines deductibility, not where it is secured.
2) Interest on a loan is deductible if the borrowed funds were used in relation to a property that is now income producing.

http://www.bantacs.com.au/booklets/Claimable_Loans_Booklet.pdf

So, starting with a PPoR worth $500k that has no debt and buying a $450k IP to rent out, I would need to borrow $485 total. I don't want to pay LMI so the most I can borrow on the IP is 80%, or $360k. I will finance $125k with a loan secured against my PPoR to buy the IP.

Loan 1: $125k secured against my PPoR
Loan 2: $360k secured against my IP
Total: $485k

IMO, better than borrowing $485 against the IP and cross-collateralising with the PPoR.

 

[perthguy]

"How does cross collateralisation affect the borrower?
When a lender cross collateralises a borrowers properties,
it has four negative effects on the borrower:
1. Cross collateralisation reduces the amount of funds
a borrower can qualify to borrow,
2. It then also reduces the number of investment
properties a borrower can buy,
3. When the initial property is the borrowers home,
it places the borrowers home at risk, and
4. It also opens the borrower up to purchasing an
overpriced investment property by not having an
independent valuation carried out on the
investment property." (source: link below)

Also a guide on how to avoid cross collateralisation here:

http://www.deden.com.au/pdf/Cross-Collateralisation.pdf