Cross Collateralization can very simply be described as the following:
Putting a loan on another piece of property you currently own and have dormant equity to acquire the funding you need for another piece or property.
Example:
You have a house that is worth $100K currently. Your total mortgage(s) is $70K. Therefore you have $30K in equity. Your option is to either do a refinance cash out for up to 103-107% of the current market value. Some lenders will allow you to do 125% of equity in the property. A majority of lenders will limit the cash out to 90% of current value, but there are lenders who will do the full cash out. The rates will not be very competitive, but you can do it. Just make sure you have all your business affairs lined up so when you do get your funds, you immediately out the funds to work. There is a cost for doing this. You would have to pay closing costs, and maybe PMI dependent on the lender and the program you choose. If you are buying another property you will have to pay some of the same costs again just to put your money to work!
If you cross collateralize a property, you would simply apply for the purchase of the target property and the lender will take a loan on your other property(s) instead of a cash down payment. This is much quicker and does not require going through the process twice just to get the same piece of property. This would save you at least a few thousand dollars if not much more and your interest rate on the collateralized property(s) do not change saving you additionally thousands of dollars in interest charges.
Bottom Line:
If you have equity in a property you want to use strictly for the use of acquiring another property, this is a very cost effective and quick method to do it. If you need some cash for any reason, then a cash out refinance would be more appropriate. Most lenders that I know that do cross collateralize have LTV’s around the 80-90% area. Therefore you would have to come up with 10-20% down on for the target property. You would then get that down payment from the property you are cross collateralizing.
Example:
Target property purchase price is $300K. You need/want a down payment of 15%. You would need $45K to put down. If you have that in 1 or more properties you can just use the $45K in equity tied up in other properties for the down payment. Of course you can also put some cash down of course. Therefore you would only have to come up with closing costs and you prepaid reserves if you escrow. The closing costs you can have the seller pay (simply increase the purchase price and give the seller an additional $25) for their assistance). Now you are left with your pre-paid reserves. On a $300K property they might be $1,00-$2,500. Therefore all you would have to do is come up with less than 1% cash to buy the property.
Additionally, if you do not escrow, then you do not have to come up with the reserves. Please be aware that most lenders charge an adjustment to of .25% of the loan value. This can be paid with cash or put into the interest rate of the loan. If you just put it into the loan, then you will not need any cash at closing. Just sign you name and walk away grinning.
Please keep in mind that you may want to explore your options for 100% NOO financing. I know of lenders that will do this if you have a credit score above 600 you can probably qualify for such financing.
If you used this first then you can acquire funding without using your dormant equity in other properties. Once you have reached the lenders loans to borrower limit, which is usually 4-10 properties with that particular lender, then you should go ahead and use the dormant equity. This would allow you to get 10 properties with minimal cash out of pocket.
If you did it this way you can acquire 10 properties worth $300K, for example, totaling $3MM in total value. Your total cost out of pocket would be maybe 1%+/- per property on the high side of costs. So now it you have $3MM of property that cost you less than $30k. And you still have the dormant equity to use somewhere else. Your first year of property ownership will give you a 100%+ return on investment so long as the area is appreciating at more than 3% a year in the given market.
I hope this helps. Of course there are different ways to do things, and not all lenders do things the same way. If you have any other questions, please feel free to contact me, see my profile for contact information.
credit to:
Pherrejon
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