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What is Cross-Collateralization and How Does It Work?

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Cross-collateralization is when one asset serves as collateral for more than one loan. If a borrower is unable to repay any of the loans secured by the asset, the property can be seized and sold even if the borrower is current on the remaining loans. Mortgage lenders and banking institutions will sometimes use cross-collateralization to reduce their risk.

What is cross-collateralization?

One asset secures more than one debt (typically with the same lender) under cross-collateralization.

For example, if a real estate investor finances a property and wants to fund an additional project, the existing property could serve as collateral for the new purchase, provided there is equity. If the borrower defaults on the new loan, the lender has the right to liquidate the existing property and use the proceeds to pay both loans, even if the borrower is current on the first.

Although cross-collateralization — also called cross-securitization — is more common in commercial real estate lending or large transactions, it does exist on some level with residential mortgages. A second mortgage, such as a home equity loan or home equity line of credit, is considered a cross-collateral loan. The home is collateral for two debts, and — unlike in the previous example — the property may be cross-collateralized with different lenders.

Cross-collateralization language: Loans, clauses, defaults

Other terms closely associated with cross-collateralization include blanket loans, dragnet clauses and cross-default clauses.

  • Blanket loans refer to using multiple assets to secure a single loan. A real estate developer may take out one loan to fund several buildings and pieces of land. The properties and land collectively secure a single loan.
  • Dragnet clauses apply to borrowers with multiple loans at the same institution. A separate asset may secure each loan, but a dragnet clause stipulates that any asset used to secure a debt can be used as collateral for any other debt with the same creditor.
  • Cross-default clauses also appear in some loan agreements. They stipulate that borrowers are automatically in default on all loans with a lender if they default on just one. This permits the lender to use assets from one loan to cover the default of another.

Credit unions and cross-collateralization

Consumers who bank with credit unions usually have cross-securitzation or dragnet clauses in their loan agreements and account terms. If a borrower has both an auto loan and a credit card with a credit union, the terms of the car loan may stipulate that the car serves as collateral for any other debt the consumer has with the lender. This practice takes an unsecured debt — the credit card — and turns it into a secured loan.

Since credit unions operate differently than banks and typically provide more favorable interest rates and loan terms to consumers, credit union cross-collateralization can offset added risk.

How does cross-collateralization impact borrowers?

If a borrower defaults on a loan secured by an asset that is cross-collateralized, they could lose the asset even if they’re current on the payments for that asset. Borrowers involved in commercial real estate transactions and credit union customers are most likely to be impacted by cross-collateralization.

A cross-collateralization clause also affects a borrower’s ability to sell an asset if it secures another loan. Consider the earlier credit union scenario. If you were to pay off the car, the lender would not release the title until you also satisfy the credit card debt, according to Leslie Tayne, a debt resolution attorney in New York City.

In many cases, consumers aren’t aware they have a cross-collateralization clause in their loan or credit agreement until they default on a debt or they want to sell a property that is cross-collateralized. Familiarize yourself with your loan terms and find out if you have cross-collateralization clauses in your credit agreements.

“Just because you didn’t realize or you weren’t told about it doesn’t mean it doesn’t exist,” Tayne cautioned.

Pros and cons of cross-collateralization

While cross-collateral loans primarily protect lenders, there are upsides for consumers. Here are some pros and cons to consider.

Pros Cons
  • Qualify for a higher loan limit
  • You may be approved for riskier transactions
  • Fund multiple properties and projects with a single loan
  • Offset a high loan-to-value (LTV) ratio by using additional collateral
  • You could lose an asset even if you’re current on the loan
  • You might be indebted to a creditor even after paying off a loan
  • Limited ability to sell a paid-for property
  • A default on one loan could result in defaulting on all loans with the same creditor

Cross-collateralization and bankruptcy: What to know

Cross-collateralization can complicate otherwise straightforward bankruptcy matters, Tayne said.

How a borrower handles bankruptcy when they have cross-collateralized debt depends on different factors:

  • Whether it’s Chapter 7 or Chapter 13 bankruptcy
  • The value of the assets involved
  • The amount of the debt
  • State and federal exemptions

Generally, you can discharge the debt or work out a plan to continue paying the loan, Tayne said.

Credit card and other unsecured debts are discharged in a Chapter 7 or liquidation bankruptcy case where cross-collateralization is not a factor. Unsecured debts are secured, though, with a cross-collateralization clause. If a consumer wishes to retain property that also secures other debt, they will need to work out a plan to repay the loan.

FAQs on cross-collateralization

What are some cross-collateralization examples? 

  • Home equity loans. Second mortgages are a form of cross-collateralization, as one asset serves as security for two loans.
  • Credit union transactions. Some credit unions stipulate that any asset that secures a loan also guarantees all loans with the same institution.
  • Blanket loans. Taking out a single loan to cover multiple transactions is a form of cross-securitization.
  • Real estate transactions. Borrowers can put up a paid-for property or one with equity as collateral to increase their buying power.

Are there limitations on cross-collateralization? Lenders cannot cross-collateralize your property without your consent. For this reason, review your loan documents to see if there is a cross-collateralization clause. If you don’t see one, ask in writing so you get your answer in writing, Tayne suggested.

How does cross-collateralization work with real estate loans? A cross-collateralization lender may place a lien on one or more of a borrower’s assets as security for a new commercial loan. This makes the transaction less risky for the lender as it gives it the right to go after any of the properties in the event of default. Also, a real estate investor looking to purchase multiple properties or land and property may use a blanket loan — one loan to secure all the properties.

Can you sell a cross-collateralized mortgage? If you have a home or other property that also serves as collateral for another property or loan, you will need to satisfy the lien against it before selling.

If you have an asset that is cross-collateralized with two lenders, which lender takes priority on the asset if you default? When two or more lenders have liens on a single property, one lender becomes the first lien holder, while the other lenders become second and subsequent lien holders. A lender’s position typically depends on when the lien was placed. If you default on an asset that is cross-collateralized, the first position lender receives payment first, followed by the lenders in subsequent positions.

 

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