Cross-collateralization can be a powerful financial tool when used judiciously because it offers numerous advantages. However, it also comes with certain risks and complexities that require careful planning and consideration. Before pursuing cross-collateralization, it’s essential to clearly understand the concept, as it can significantly impact the way investors structure their property investments and secure a cross-collateralized real estate loan.
What is cross-collateralization?
Cross-collateralization of assets is a financing strategy used by borrowers to leverage multiple properties as collateral to secure a single loan from the lender. Essentially, it means that the borrower offers more than one property to secure a debt obligation. This approach can be beneficial for both borrowers and lenders. For lenders, it provides additional security and reduces risks, for which borrowers get access to more capital.
Cross-Collateralized Real Estate Loan Explained
A cross-collateralized real estate loan is a loan that employs multiple properties as collateral (an asset that works as security for the amount you borrow) to secure a single loan from a lender. Instead of pledging just one property to secure a loan, the borrower can pool together multiple properties, decreasing the overall loan-to-value-ratio (LTV). This can be a potent option for investors looking to maximize their borrowing capacity by leveraging multiple properties.
Using a cross-collateralized loan makes sense for real estate investors who don’t want to tie up their available capital. A loan secured by a single property may fall short of meeting these funding needs, but a cross-collateralized loan can provide the necessary financial leverage. By combining multiple properties as collateral, borrowers can access a larger loan amount to fund their projects.
Securing a Cross-Collateralized Loan with HCS Equity
While traditional lenders like banks and credit unions may not offer cross-collateralized loans, such loans are commonly secured by hard money private lenders for several reasons.
Hard money lenders such as HCS Equity are generally more flexible when it comes to the types and conditions of properties used as collateral. We’re often willing to consider a wide range of property types such as single-family home, multi-family property, commercial, retail, etc. (including those that may not meet the strict criteria of traditional lenders).
When assessing loan applications, we primarily focus on the combined value and potential of the properties instead of relying on the borrower’s credit score or financial history.
How to Structure a Cross-Collateralized Loan
Structuring a cross-collateralized loan with private money lenders can be a complex process, particularly when it comes to planning how the loan will be settled. Since no single property has enough equity to fully cover the loan amount, it’s crucial to rely on the proceeds generated from the sale or refinancing of one of the properties used as collateral. This ensures that there will be enough equity in the remaining property to reassure the lender.
For instance, consider a borrower who decides to secure a loan of $150,000 by using two properties, each valued at $200,000. In this case, the combined value of the two properties totals $400,000. The lender would then secure the $150,000 loan against both properties, resulting in $250,000 of total equity.
However, if the borrower proceeds with selling or refinancing one of the properties without paying down the loan balance, the loan would solely rely on the remaining property for collateral. This would reduce the total equity securing the loan to just $50,000, significantly increasing the lender’s risk.
To mitigate this risk, lenders often implement a specific loan requirement, commonly referred to as a “release provision,” in the event that one of the properties is sold. The release provision specifies that the borrower must reduce the principal balance of the loan to an amount that the lender deems adequate. This requirement is agreed upon before the loan is disbursed, ensuring that there are no disputes when a sale occurs.
The Final Words: When a Cross-Collateralized Loan is a Good Idea
A cross-collateralized loan can be a valuable financial tool when used in the right circumstances. While it may not be suitable for every real estate transaction, there are specific scenarios where opting for a cross-collateralized loan makes sense.
For example, a cross-collateralized loan is an excellent choice when investors need access to a larger amount of capital than a loan secured by a single property can provide. However, they must own multiple properties with sufficient equity in each property to be able to qualify for this type of loan, which in turn reduces the lender’s risk.
While cross-collateralized loans offer numerous advantages, such as more favorable terms, including competitive interest rates and longer repayment periods, they also come with increased risks, including the potential loss of multiple properties if you default on the loan. Therefore, borrowers should seek professional guidance from HCS Equity before pursuing cross-collateralization.
Contact HCS Equity today to acquire a cross-collateralized loan and fund your real estate projects effectively.