Before signing a cross collateralization mortgage, a borrower should review all the terms with his or her real estate lawyer to determine whether this type of loan meets his or her needs. Lenders use cross collateralization to add security to a loan transaction. This is done by placing a lien on the property that the loan is intended for and another property that is owned by the borrower. The additional collateral reduces the lender’s risk. However, this type of mortgage can pose future problems for borrowers if they decide to sell one of the properties or default on the loan because both properties are then tied together.
Why Choose a Cross Collateralization Mortgage?
When a borrower does not have the cash flow to purchase another property, putting up a property that he or she owns as collateral can be appealing. This gives buyers leverage to buy a second property without having to use their own cash. Technically, a home’s second mortgage is also considered a cross collateralization loan, because it uses the home as collateral. When used in a smart way, this type of loan can allow borrowers to take advantage of better interest rates.
A Cross Collateralization Mortgage Benefits Lenders More
With a cross collateralization loan, the lender is at an advantage over the borrower. It is possible to have a cross-collateralized loan instead of a stand-alone loan without knowing it if the borrower does not fully examine his or her loan contract. When possible, a borrower should opt for a stand-alone mortgage because:
- If the borrower defaults on a cross collateralization loan, the lender can foreclose on both properties. This causes two foreclosures to appear in public records and on credit reports, which could damage the borrower’s ability to borrow money in the future.
- There could be penalties tied to a cross collateralized loan if it is paid off within two to five years.
- The fees associated with closing a cross collateralized mortgage can be expensive. The lender could require that both properties be physically appraised, which could lead to demands for repairs being made before closing can occur.
- Cross collateralization mortgages are inflexible and make it difficult to sell one or both properties because they need to be separated and re-collateralized.
- The borrower will not benefit from increases in equity in the properties tied up by the cross collateralization mortgage, which makes purchasing more properties difficult.