What is worse than a decline? Being tied up in red tape is what is worse ! I had some new clients come in last month and I would call the loan structuring they were set up with by their bank a Big Mess! Capitals! Why? All three properties and all three loans were cross collateralized. They wanted to sell one property and move to the coast, but without a specialist to untangle this contractual mess, they were stuck. What is it? It is where the bank or lender will secure one loan with more than one property in order to improve it’s equity position. In effect, the bank sinks it’s claws into as much property as it can, on as many loans as it can. I use this term because in most cases it is unnecessary. Also, banks aren't inherently being 'bad guys' it is just sometimes the old school way of doing things, and completely unnecessary in this day and age in most situations. In the graph below, the loans represented as $ are mortgaged to the houses attached by lines. In this example, two mortgages are cross collateralized against three properties. To sell one property, the bank must revalue the related mortgaged property. From here the bank will determine how much they want the mortgage reduced by the sale. Can it be avoided? Yes! With the help of your mortgage broker, you can choose to split your loans so that they are all ‘stand alone’. I.e. if you need equity out of your home to buy an investment, simply take out the deposit and costs as an equity loan, separately, that is only secured by your home. Then, take out an investment home loan against the investment property. You’ll end up with two loans but as both were used for investment both are tax deductible. When it comes time to sell your home or the investment, you will know exactly which loan needs to be paid off. If you cross collateralsed however, the bank can hold one property ransom to the other, demanding that you pay down debt other linked loans! I have seen this nearly bankrupt people in falling property value markets. In one particular case, I saw a bank try to force their hand claiming that the loans were cross collateralized. I investigated for the client and found they were stand alone, thus releasing the clients from a near fatal financial blow. This is the difference between someone who is an expert at structuring mortgages, and someone that isn't, or simply chooses not to care for your financial well being. The below graph illustrates a nice neat 'stand alone' mortgage structure, avoiding all the pitfalls of crossed securities. If any of these properties were to sell, the mortgagor would only need to pay off the linked loan/s. There is no confusion down the road, and no obstacles to refinancing individual home loans. Further benefits are that if you require lenders mortgage insurance, because your equity is low, stand alone structuring will result in a considerably smaller premium. That saves thousands when we compare scenarios for our clients, to helps to better understand good loan structuring.
All the loans can be split by purpose for your accountant too, to make tax time easier. Further you can have greater control over where your surplus funds are going and which loans are being paid off faster. Preferably the rule is the non-tax-deductible ones! Suffice to say our new clients have now removed two investment properties from their own home, thus relieving a great deal of stress and ensuring that their 'castle' is safer.
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![]() Jane was a young mum with a toddler, a baby and a home business. Jane really needed a place of her own. She wanted to paint and put hooks in walls. She wanted to set up a home office where she could meet clients. What she could not understand was why she couldn't get finance. The banks she had been to had told her that she couldn't qualify for a loan with them as her deposit was too small. On a small budget raising two kids, her husband working, there was not much left after rent and bills. She knew she could afford a mortgage, with rates so low, the mortgage would cost the same as rent! Fed up she asked a friend for advice and they recommended the services of our brokerage. Jane got in touch with Matt in our office who quickly explained that Jane’s deposit was indeed, simply too small. To buy the land and build the house she wanted, she would need wait and save, OR find a guarantor. A guarantor? This was the first time anybody had mentioned a second option to her, so she was keen to know more. “What exactly would they need to do?” she asked. Matt being a guarantor specialist, explained that a guarantor offers up a limited amount of the equity in his or her own home or investment. With this, Jane and her husband, Don could cover a full twenty percent deposit and costs. Then the remainder of the mortgage would be financed without a guarantor. This is the banks way of structuring guarantor finance, as it lowers the exposure for the guarantors to just small part of the mortgage. Jane had already saved enough money to cover costs, so her guarantors just needed offer around sixty thousand dollars as a guaranteed mortgage. There was no cash required from the guarantors; they simply needed to be comfortable allowing a mortgage on their property for this amount. Jane spoke to her parents that night. She knew they had always been interested in helping her step into the property market, and they said yes. They wanted more details so a call was a arranged with Matt as they were in another state. Matt called them and explained everything, including the banks requirements to consider seeking independent legal and financial advice. The parents were satisfied and wanted to proceed. They had one condition; that Jane and Don took out some income protection insurance and life insurance. We got George our Financial Planner to start work on that straight away. This was the insurance for our clients, as much as it was for the guarantors. It meant that should any illness or accidents occur that prevent them from making an income, everybody would be protected. Jane was ecstatic, she now had pre-approval to purchase land, and build the home they had dreamed of living in. Don was happy too, and seemingly grateful that Jane, Matt and the in laws were handling all the paperwork! A guarantor is not a complex arrangement, and many major banks and lenders will offer this service where the deposit is insufficient. You simply need to ask! In our experience, around one in five buyers have a parent who is willing to offer a guarantee. Having a guarantor also saves our clients lenders mortgage insurance premiums, and means we can negotiate a lower rate as the risk is much lower for the banks on these loans. Parents – you’ve got to love them! |
AuthorLiz Wilson has been working in finance for nineteen years now. She regularly blogs on industry topics and here you will find over a hundred personally written blog topics and case studies... Archives
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