Have just read Steve McKnight’s “From 0 to 260+ Properties in 7 Years”, and to contrast this, have started reading Margaret Lomas’ “The Truth about Positive Cash Flow Property”. While their experiences differ in a few key areas, the basics are the same. However, they do differ on Cross Collateralization.
Steve has a single paragraph on p167 in the chapter on “How to survive and thrive and a property downturn” that says to avoid Cross Collateralisation. He says it’s “total overkill” (for lenders to reduce their risk) and “In a worst-case scenario all you need is one asset to go bad in a cross-collateralised portfolio for a domino effect to occur which puts every asset at risk.”
Margaret Lomas, however, recommends an all-in-one cross-collateralized line-of-credit loan (pp73-80) because:
* Line-of-Credit loans can be split & rearranged into different accounts, so makes tax accounting easier (and cheaper).
* When all properties have grown a little (say 4 properties go up by $10k each), you can revalue them all and you have enough to buy another property, if deposit and purchase costs were $40k. If you held 4 separate loans, you’d have to wait till one of them goes up by $40k before buying another property. (I see the $$$ here!)
* You choose where/when to reduce principal. Flexiblity/control. Discipline comes from you not the bank’s repayment schedule. (Obviously, if you have no discipline…)
* Managing one loan is easier than lots of loans with different banks.
* Not my bag, but you could include personal loan items in the same line-of-credit loan, if you’re disciplined enough.
* Can sell a property and buy another (equal or cheaper) in it’s place without a new loan application.
* You can keep the same loan forever, so avoid hassle of finding new loans / refinancing / setting up direct debits. (But I thought that was all part of the fun?)
* Holding each loan with a different bank isnt safer, because you still have to pay back what you owe. If you default with Bank X, sure they’ll sell the collateral you gave them, but if that’s not enough, they can also sell the collateral you hold with Bank Y and Bank Z.I have to admit, that at this point in my reading, Lomas has proven her point much better than McKnight. Anyone care to stand up for Steve on this? What’s so bad about CC?
harvest,
One of my portfolios is CC and I haven't had any problems with it.
There are a lot of negative comments about CC and it is mainly based around if something goes wrong the risk of losing all etc.
Lomas comments about the overall equity increasing is correct and can be used to acquire other properties very easily.I'm sure others will point out all the pitfalls of CC.
I think the problem occurs when you grow a massive property portfolio. Don't forget that Steve's book is 200 plus properties.
So for an example you have 200 properties cross secured and property 201,202 and 203 go belly up you risk losing property from the 200 plus properties. Also when you own 200 plus properties they are not going to be owned in your name but rather in a trust and company name as owner of trust. Another problem is you reach a total loan value of 1 million and the banks make it hard to borrow from them .
I am thinking of using cross securing because of low cash flow making it hard to get a loan by itself where as a cross will allow me to borrow most of the loan I need from my line of credit and a small amount from a cross security loan.but I do not own 200 plus properties. Also it is hard to swap the structure of property purchased prior due to capital gains tax and stamp duty having to be paid if you transfer from individual ownership to a trust ownership.
What I've done is use my PPoR and first four IPs all CC'd as security for a reasonably large LOC. I now keep all new properties stand-alone except for using the LOC for the 25% equity / buying costs required.
I find this a good compromise. I'm limited more by my debt servicing capacity rather than my equity, ie my PPoR and four IPs tend to provide all the equity I can use, so I don't need to cross collateralise any new properties.
The LOC can be divided into several sub-accounts which makes the accounting a lot simpler, but it's not essential. It is vital however, to keep any private sub-account well separated from the investment sub-accounts.
It's probably a good idea to keep any share investments separate from property in a big LOC as I've recently come to realise. I just shifted all my shares into my super fund (because I'm now at the age when I can draw a TTR pension) but in doing so, all that portion of my big LOC that was used to purchase shares is now effectively private debt. I can't pay that part out separately; I must apportion any principal repayments between the investment and private parts. The only way to kill my private debt now is to pay out the entire balance of my LOC.Just one other point on Steve's portfolio. If you listen to his disc at the back of his book, he'll tell you he didn't have more than about 80 properties at any one time. He's done a fair bit of selling as well as buying.
The only valid point she makes is the second one. If many properties are increasing just a little, it can be hard extracting equity.
What about the downsides:
– you reach serviceability with the lender, but have equity = you are stuck
– 1 of your properties has dropped in value, and you want to sell the 2nd one = you cannot unless you pay down the loan on the remaining.
– you default = the bank could take any security and sell that. (if you had property with other banks you would still have to pay back some money, but you could chose how to do it).
– etcTerryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
What stops the bank from trying to recover debts from other properties you have with other banks?
CC just makes it easier for the banks but they can still go after other properties.c2
Bank A would not have a mortgage over property with bank B so they would have to go to court and then get a judgment against you, then take further steps by getting a court order to sell property. If they have a mortgage it is a much simpler and much quicker process.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Thanks Terry.
Good point about the increase in control & difficulty for bank to reclaim funds upon default, if not CC’d.
You said: “1 of your properties has dropped in value, and you want to sell the 2nd one = you cannot unless you pay down the loan on the remaining.” but I dont understand. Could you elucidate?
Easier with an eg.
say you had 2 properties purchased for $200,000 each and a 90% loan. Total security is $400,000, total loan is $360,000.
Now say the market has dropped 10% and you need to sell one property quickly because of financial trouble. You can only get $180,000 less costs maybe $174,000 in your hand.
You apply to the bank for a release of security and they say they will need to value the remaining security.
The value comes in at $180,000 so you must reduce the remaining loan to 90% of this figure = $162,000.So from the original loan of $360,000 you minus the sale proceeds = $186,000. This is what you are left with when you pay all the money into the original loan. But the max loan size is $162,000 so you will need to come up with another $24,000 before the bank would release the security.
You were be hurting even more if this happened.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terrys example is text book perfect – explained 100% spot on, and unfortunately occurs daily………………….a great reason why anytime money is borrowed for property, you really need to look at what you want to achieve, and your l-o-n-g term goals/plans prior to making a committment.
Cheers
Getting back to my eg.
Imagine if you had the foresight not to cross collateralise hte properties. Selling one would not effect the other and no valuation would be needed. If the value had fallen you could just hold the loan as is and wait for growth to kick in again.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terry,
The example is good but relies on a falling market and the person wanting to sell.
What about buy and hold investors in rising markets like the last 6 years?If the plan is to buy and hold then CC doesn't look that bad an option if the only way to secure the deal.
As prices rises you should be able to change from CC to individual loan/set ups etc.Hi CC
I can't see the point of CC really. If you can CC you can get away with no CCing and save yourself the hassle (more fees and valuations etc).
The above example happened to a guy i know who purchased around 4 years ago. We can't always predict whether the market will rise or fall so it is best to prepare for the worst just in case.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Agree with Terry. He wasn't your client at the time he purchased was he?
I will say that the asset protection theory is a myth, because the bank can sue you to chase your assets even if they don't have a mortgage on it. It just removes an additional step in the process of them getting their money back.
Say you have a portfolio that mixes residential in with commercial. Rates can vary massively from different lenders with some offering fantastic fixed rates for commercial, but the big banks are currently pretty hard to beat with residential; previously I was paying 9.49% with one of the majors (for a business loan) and got it refinanced to under 6% with another lender. My lender could not match the rate and features. If it were cross collateralised, I would not have been able to do this so easily, and the bank would want revalue the whole portfolio as soon as you took the commercial chunk out. This would have cost about $100 per $100,000 in value, and an additional $300 admin fee for each property. An unnecessary additional cost, and if you own a fairly large portfolio with multiple properties, it can be a MASSIVE unnecessary additional cost.
Avoiding cross collateralisation not only gives you flexibility to sell when you need to, it also gives you flexibility to change banks and refinance when you see some better deals around! You can avoid cross collateralisation and still access the same amount of funds, so why would you do it?
I just wanted to chime in with my two cents worth.
I agree with the well articulated responses above. CC is, and should ramain, avoidable in almost all cases. Keeping your properties seperate shouls always be the preferred option. By doing this, you are not protecting your assets, but you are protecting your position of control over your assets. Asset protection is a myth, but it important that you hold the cards if changes need to be made.
This become a lot more relevant when it involves your family home. The last thing you want to do is start with a great plan and a lot of equity, and end up on the street with a whole heap of 0 equity properties and looking for a place to rent.
If your single CC portfolio is with an institution that has a big policy shift ie Check vals annually or similar, it leaves you exposed to the whims of that institution. Spread your risk, and use different institutions.and also………
People that do not understand why you have to reduce residual debt are not smart enough to use words like 'elucidate'.
All the best.
Awesome Thread !- very useful information indeed
Just one question, if you go to the bank and say you want to take out another loan and only have it secured against the new IP, is there a way to distinguish whether the loan is CC or not? I mean it’s all good in word but if the lender makes a blunder and CC anyway, how would one know?
Look at the wording in the Letter of Offer.
Some lenders insist on it and some just do it without you even knowing. Both would be ones to avoid.
Richard Taylor | Australia's leading private lender
I may be missing something here.
How do you avoid CC when you are using equity in property A to purchase property B and you don't actually have a cash deposit? Maybe I CC just the two properties, and then when property C comes along, I again CC property C and A. At some point I could have the CC between A and B removed when I have enough equity in B?
Cheers
SHi Terry,
You can always Not CC the properties even you borrow the money from the same bank if you structured it correctly.
You mentioned " 1 of your properties has dropped in value, and you want to sell the 2nd one = you cannot unless you pay down the loan on the remaining"
So.. the bank can even sell all your properties if you hold them on the same bank eventhough without CC?
Cheers
NEVER CC
If you default on one of your loans the bank will take/auction off the property with the most equity to recover their funds eg principal place of residence. You can always draw down on your equity on a stand alone portfolio. You might have to repay mortgage insurance(depending on gearing level) but its a much safer option.
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