Cross-collaterisation is a topic that often confuses many people. There are benefits of using this structure for a property purchase, but if you are thinking about building a portfolio you need to know the risks associated with it.
It is easy to be amazed at how your friends or work colleagues are buying investment properties, especially when they are on similar salaries and have similar lifestyles to you. There is no secret. What many do is use the equity they have built up in their home to give them a kick start. Over the last 10 years home values throughout Australia have increased, and in some instances doubled. This essentially provides every home owner a source of funds that they can now use. Some have used these funds to upgrade their homes, buy new cars, or make an investment, be it superannuation, shares or property.
Equity is the difference between the value of a property and the loans against the property. In this article we will be looking at using your available equity so that you too can purchase an investment property. Available equity is the actual amount of your equity that you can take out and use. Most lenders require you to keep 20% of the house value quarantined as a buffer. There are few ways that you can then access this available equity, putting it to work for you rather than letting it remain dormant. Two of these methods are discussed below:
- Cross collaterisation. You can use the equity available in your home to purchase an investment property by securing the new purchase with both your home and the new property. Essentially this means you put no money down and the lender combines your home and investment together, giving you a new loan for the purchase price and the costs of purchase, i.e. the new loan is higher than the purchase price of the new property. The very important thing to remember with this strategy is that your home is directly linked to your investment property and the lender will take the title over your home to secure the new loan as well as the title over the new property.
- Separate loans. This allows you to access only as much equity as you need to cover the deposit and costs of the new property as a top-up loan or line of credit against your home. Once this is done a separate loan, which may even be with another lender, is taken for the remaining funds required to complete the purchase on the new property. Once again there is no money down required from you, however the titles of your properties are separated and you have greater flexibility. Another advantage of doing it this way is you may find you have enough equity and serviceability to complete a second purchase.
There are positives and negatives with each of these structures. Those using cross-collaterisation will find that over time, lenders invariably start dictating terms, which you may not be comfortable with. For example, they will only lend you money based on the new investment loan being principal and interest, rather than the norm for investors, which is interest only. One of the main issues is that your only portfolio growth may have to stop as the bank will not lend you anymore funds. Imagine you have a house in Perth and over the last few years the value increased from $250,000 to $300,000, meaning you have greater equity to tap into. Now let’s assume you also have a two-bedroom unit in Western Sydney that was worth $250,000 five years ago, but today it is only worth $200,000.
Your portfolio is stagnant as it is still worth $500,000, despite the prices of individual houses changing. Hence the lender will be reluctant to allow you to access the equity from your Perth property. If you had followed the separate loan strategy and kept all your loans separate then it could be possible to access the equity from the Perth property to allow you to purchase again. You may even decide that you want to maximise your available equity and not use the full 20% deposit for the new investment purchase. This would mean that you will need to pay mortgage insurance. Mortgage insurance is a borrowing cost and hence tax deductible over five years for investment properties.
Many investors use mortgage insurance so that they can buy more than one property using their available equity. An often misunderstood concept with the separate loan structure is that the new top-up loan or line of credit although secured against your home will still be considered an investment loan and hence the interest will be tax deductible. One of the benefits of cross-collaterisation is that you do not have to pay mortgage insurance, as the lender is tying up all the available equity in your property rather than just the amount required.
You will find that the lenders are delighted to assist you with this structure as it makes it harder for you to leave them and difficult to separate the loans in the future so you must work with that same lender for any future purchases.
In summary, most investors want to combine the benefits of using none of their own savings with the tax minimisation advantages when buying an investment property. Releasing equity from your home in a structured way allows you to keep your savings in the bank.
Your savings could even assist you further by putting them into a 100% offset account against your personal debt, i.e. your home loan. Accessing equity in your home or current investment property allows you to leverage your current situation and use the lender’s funds to assist you in buying a property and hence buying you time in a growing market.
Property investment is a long-term strategy in assisting you in achieving your goals. The more exposure you have to a growing market the more opportunity to grow equity and in the long term the more equity you have to help you fulfil your goals.
Bear in mind that all geographic markets do not grow at the same time or at the same rate, so spreading your exposure and hence risk across different states, towns or suburbs is one investment strategy to reduce risk. So buying an investment property around the corner from your home may not give you all the advantages you imagine. Obviously you need to be comfortable that you can service any new loans and maintain a standard of living.