Calling all investors ….have you been caught in this all too familiar trap?
A common scenario I’ve been seeing more of lately is property investors who have allowed themselves to get caught in the “cross-collateralisation trap”. If that is you, I feel sorry for you, but I do understand as it is such an easy trap to get into but a little harder to get out of.
The trap occurs when a Lender manages to convince you that it’s in your best interest to give them all or a number of your properties in exchange for them giving you something, usually an interest rate discounts. (They don’t mention of course that they are really doing it for their benefit because it means a whole lot more income out of you, without them doing much more hard work.)
Generally speaking, in my long experience, I’ve found that what tends to be of most benefit to the Lender is rarely of equal benefit to the Borrower!
I don’t see bundling all your properties with one Lender as a good idea for a number of reasons. When you hand over your properties and allow them to be “crossed” recognise that you are handing over CONTROL of your portfolio to the Lender. Make no mistake about that.
Once you do this, it means they control the security. They control your ability to borrow. They control your ability to use your equity and, more importantly, they control the flexibility you have to move forward. In essence you are letting the Bank decide if you will become rich or not. Do you really want that?
The reason they do this, is because a Lender will reduce your ability to borrow depending on the amount of debt you have with them. (If you have too much debt with them, they will feel they are carrying too much risk, so they tend to want to reduce the risk you represent to them. Their only way to do this, is to restrict your borrowing limits.) Sure, initially they want you to give them the loan business and they are prepared to offer you lower interest rates to secure your loan business but once you are on board recognise that they will start putting restrictions on you by lowering your LVRs for future borrowing. Talk about giving you mixed messages!
I believe that your ability to borrow the maximum for each property you invest in, whether it be for a reserve or as equity for another property should be vigorously defended. This is your negotiating tool, your bargaining chip with future lenders because you can go elsewhere. Remember, this is your future we are talking about, NOT the Lender’s!
I do understand that sometimes it is logical to give up a number of properties to a Lender because of location or property type. In some cases the post code may not be acceptable or the security is unique, such as in the case of student accommodation for example and the number of Lenders may be limited. If you have a number of these types of properties then your choices may be limited so taking advantage of a Lender providing discounts for a large aggregated loan size makes sense.
Broadly speaking however I believe you will find that a selection of separate, investor friendly lenders is of more value to you in the long term, than a single Lender offering an interest rate incentive for you to consolidate everything with them.
This is also because I believe that it is desirable for investors to only have properties that ANY Lender will give at least 80% LVR on , so I prefer to avoid properties that don’t fit that criteria.
The only reason I can see for having a cross-collateralised portfolio is to use the strength of the better properties in the portfolio to prop up the weaker properties in it. But in my opinion, you would be better off to avoid the weaker properties in the first place. If you apply my 80% LVR rule, you won’t need to get yourself into the cross-collateralisation trap in the first place.
Trust me, keeping your portfolio in good shape and flexible enough to change as times changes, is of far more longer term value to your overall wealth creation strategy than the short-term apparent advantage of an interest rate discount. Because believe me I’ve been involved in trying to undo complex cross-collateralised portfolios before and it sometimes just can’t be done. That for any smart property investor is a situation you definitely don’t want to get yourself into.
If you would like to discuss any aspect of this article with me, feel free to contact me, Vincent Power at Investors Direct at firstname.lastname@example.org