What is Cross Collateralization?
Have you been using your hard earned cash to buy properties and build your real estate portfolio?
Have you identified some new properties to purchase but don’t have the cash to acquire and renovate them?
If you’ve got free and clear properties, you might not need to use any of your cash to grow your real estate business.
Here are some tips for cross-collateralization. Learn how to use your equity to help fund future investment projects.
First, let’s make sure that you understand this term. Cross-collateralization is a simple concept and an option that you might not have considered.
With cross collateralization, you’re taking collateral from one loan to cover the collateral for another loan. In this case, your existing collateral is the equity that you’ve got on your existing properties.
For example, you’ve got a $200K property with no mortgage. This means that you’ve got $200K in equity on that property.
Now, let’s say that you want to obtain a loan to purchase a new property. You can get a loan up to 80% of the costs LTC (loan to cost ratio). This would leave 20% that you need to bring to the table for the new property. You could use some of the $200,000 in equity from the previous property to cover this.
That’s the basics of cross collateralization. But, there are a few things that you’ll want to watch out for…
The Dangers of Cross Collateralization
Before choosing this method, you’ll want to explore the dangers of cross collateralization. This includes:
- Less flexibility
- More complexity
- Equity issues
Cross-collateralization could limit your options moving forward. There is less flexibility in completing a sale. For example, the lender may require you to use the profits from the sale of one property to reduce the loan on your other property.
Also, there is more complexity involved in these loans. If you need to sell one property, the lender may require an assessment of all properties involved in the cross-collateralized portfolio.
The next issue to consider is the impact that equity from one property can have on the equity of the other property.
Here’s an example. You’ve got two properties that are part of a cross-collateralized loan. The equity that you’ve got available is the sum of the equity in both properties.
If one property drops in value, it impacts your total equity. The two properties are now connected, up to the amount of equity used on the existing property – or properties.
This shouldn’t scare you off from using cross collateralization to help you access capital for your next real estate project. This method can be the right move, if you’re careful and work with a quality hard money lender in the state of Pennsylvania.
The Advantages of Cross Collateralization
Now that we’ve covered some of the dangers of this method, you should explore the advantages that it can bring:
- Allows you to get started on your next project with zero down
- Helps you continue to grow your real estate business
- Cross-collateralization can be easier to manage
The main advantage of cross-collateralization is getting started on your next real estate project without needing a down payment.
Most hard money lenders will offer loans in the amount of 70-80% of the cost of the property. In Pennsylvania, Legacy Capital offers loans up to 80%. This still leaves 20% that you need to cover.
With your existing equity, you don’t have to come up with that 20%. This also allows you to continue growing your real estate business.
This could make it easier to manage your finances. Instead of having multiple loans from different lenders, your eggs are in one basket. You’ve got one lender to work with. This can also increase your chances of obtaining future equity loans from the same lender.
Should You Use Cross Collateralization?
In the end, the decision is yours to make. If you want to continue pursuing additional real estate investments but lack the funds, your existing equity could provide a suitable option.
You’ll need to weigh the pros and cons of this method. There are risks in cross collateralization. Your existing equity becomes tied to the equity of your next project. Also, you might have less control over the sale of the existing property.
At the same time, this method can be very rewarding.
If you work with a reliable hard money lender, cross collateralization could be the perfect solution. If you’ve got free and clear properties or properties with a lot of equity, then keep this option in mind the next time you need to come up with funds for a hard money loan.