What Is Cross Collateralization in the Hard Money Industry?

Purchasing real estate for investment purposes is an interesting endeavor. For example, investors can do a lot with commercial real estate transactions that would never be allowed in a residential scenario. Cross collateralization is a good example.

Cross collateralization is the practice of using multiple pieces of property as collateral on a loan. To be clear, cross collateralization is limited mainly to the hard money space. An investor would be hard pressed to find an institutional lender willing to go along with a cross-collateralization scenario.

Private Lenders Aren’t Banks

Getting a handle on cross collateralization starts with a bit of knowledge about private lenders. First and foremost, they are not banks. Most private lenders are organized as firms that manage funds on behalf of individual investors. That is exactly what Salt Lake City’s Actium Lending does.

Actium says that most of its hard money loans go to real estate investors. But they also say that all private lenders are not organized as firms the way they are. Indeed, a private lender could be an independently wealthy person willing to lend money on his own.

What does all of this have to do with cross collateralization? Let us look at how hard money loans are approved.

Collateral Value Is Everything

Unlike institutional lenders, hard money lenders do not spend a lot of time and effort trying to determine a borrower’s ability to repay. Rather, lenders are interested in collateral. Collateral provides backing for a hard money loan. Furthermore, transactions are normally conducted as trust-deed transactions.

Under a trust deed arrangement, the deed to a property is held in trust by a third-party for as long as a loan remains outstanding. That third party is almost always the title company that facilitated the sale. It can be any other third-party the borrower and lender agree on.

Regardless, trust deed transactions are utilized in hard money because they make it easier for the lender to facilitate legal action in the event the borrower defaults on the loan. As far as collateral value is concerned, it determines approval. If a loan is approved, collateral value also impacts the amount the lender is willing to offer.

The Property Being Acquired

Actium further explains that real estate investors tend to offer the properties they are acquiring as collateral on their loans. But what if a property under consideration doesn’t have enough value to cover the amount requested? That is where cross collateralization comes in.

Cross collateralization dictates offering multiple pieces of property as collateral. An investor might pull a property or two out of his portfolio and combine it with the new acquisition to secure a hard money loan. It is up to the lender to decide whether to proceed.

Cross collateralization helps borrowers by reducing the amount of cash they need to bring to the table. It helps lenders inasmuch as having multiple pieces of collateral to work with reduces risk. More collateral equals more value. More value equals a less risky loan transaction.

There Are Downsides to Cross Collateralization

Understand that there are downsides to the practice. From the bower’s perspective, the biggest issue is potentially losing multiple properties if he cannot make loan payments. From the lender’s perspective, cross collateralization suggests there may be issues with the target property. Is there enough reason to warrant denying a loan request?

Cross collateralization is not that unusual in the hard money industry. It is something that investors take advantage of pretty frequently. As long as it works for both lender and borrower, no problem. But it is still a risky proposition.