You have already heard of collateral and collateralization as a requirement to be approved for some loans (called secured loans). But, what is cross collateralization? This technique can help you maximize your assets to secure multiple loans. Let’s see how it works.
What is Cross Collateralization?
Cross collateralization comes in two forms. In the first one, cross collateralization implies using an asset that is already being used as collateral for the first loan to ensure the second or more loans. Also, cross collateralization can imply that several assets ensure one or more loans. This is usually the case when the borrower has multiple loans with the same lender.
To better understand these terms, let’s define what collateral is. This term refers to assets and property, such as a house, car, business inventory, or others you pledge to a lender to get a loan. If you fail to pay your debts, the lender has the right to seize your promised belongings. Given that this act provides the lender certain security, this type of loan is called a secured loan.
After learning what cross collateralization is, it’s time to see how it actually works.
In What Situations Can You Find Cross Collateralization?
One of the most common situations where you can find cross collateralization is a second mortgage on the property. Thus, when you take the first mortgage on your house, you pledge it as collateral. For the second mortgage on your house, you’re using the existing equity in your house as collateral.
Another scenario where you can encounter cross collateralization is when a real estate investor presents multiple real estate properties to be approved for a single loan and thus ensure funds necessary for their development. This is called a blanket mortgage.
As you can see, cross collateralization is used by consumers and business owners. For example, if you have a personal loan, a car loan, and credit cards at one financial institution, you can use these assets together as combined collateral for all of your loans.
The same goes for a business owner who, let’s say, has an equipment loan, a line of credit, and any business secured credit card at one bank. Just have in mind that if you default on any of these loans, the lender can seize collateral from others to recuperate losses.
Last but not least, cross collateralization is usually used in auto lending when you borrow money to purchase a car or any other vehicle. This type of loan is typical for credit unions that operate differently from banks. This difference is reflected in the loan agreement which states that the car or other vehicle represents collateral for the loan. Besides, it also declares that collateral securing that loan will also secure all other loans with the credit union. In other words, the credit union has a lien on that vehicle to secure all your other future loans with them.
What Types of Assets Can Be Used as Cross Collateral?
The last piece of the puzzle necessary to grasp completely cross collateralization is to see what types of assets can be used as cross collateral.
If you’re considering getting a business loan, you can pledge:
- Home equity
- Business or personal vehicle
- Business or personal real estate
- Business equipment
- Business savings accounts
- Investment accounts
- Insurance policies
Still, we need to answer one more question and the most crucial one. Keep on reading!
Is Cross Collateralization a Good Idea?
Cross collateralization may be helpful on one hand, but on another, it isn’t the best fit for everyone. If you’re considering this way to secure a loan or multiple loans, you need to take into account all benefits and downsides before signing a contract.
Pros of using cross collateralization
1. Easy to qualify
One of the principal benefits that cross collateralization brings is higher chances to get approved for a business loan. Traditional lenders are very strict when deciding who qualifies and who doesn’t. Their decision is based on your personal and business score, cash flow, time in business and many other factors.
However, collateralized loans are risk-free for lenders because they can leverage your asset for cash in case you don’t pay your loan back. This type of loan is especially convenient for people who aren’t eligible for traditional loans.
2. Low cost
Another reason why cross collateralization is so beneficial is the lower cost. Compared to unsecured loans, secured loans are cheaper. In other words, you can expect lower rates and longer payment terms. Besides, the more valuable asset you’re pledging, the more favorable terms you can expect.
3. You can take advantage of existing assets
Cross collateralization represents the opportunity to use the assets trapped in existing loans and make them liquid once again. Just because you’ve already offered collateral to get a loan, it doesn’t mean that you can’t take advantage of its value to ensure more loans.
Cons of using cross collateralization
1. Huge risk
In case you fail to pay back your debts, the lender will take your asset, so there’s a lot at stake. Likewise, the more properties you offer, the greater the risk is since you can lose everything. That’s why you should consider this option if others are unavailable.
2. You are tied to one lender
Another downside of cross collateralized loans is that all your properties are usually with the one lender and it can be difficult and expensive to move them to another lender. Therefore, you’re stuck with the terms of a single lender.
3. Not so favorable terms
Sometimes there can be some difficult standards to meet, especially if you’re applying for a second collateralized loan. This is usually because the lenders have to protect themselves in case of a default and the reason why they offer more strict terms than the first time.
After analyzing the pros and cons of cross collateralization, the bottom line is that it’s not the best option, like secured loans in general, because it represents a great risk. Taking multiple loans (also called loan staking) is never advisable since it can strain your finances and put you in a vulnerable situation. You can consider it only when its the only viable option.
Fortunately, remember that not all lenders require collateral. One such lender is Camino Financial.
We offer small business loans that don’t require pledging collateral, so all your personal and business assets are safe. Therefore, there’s no risk of losing your belongings. Our business loans have more flexible requirements than what you’ll find with other lenders, in an effort to follow our motto “No business left behind”.
If you’ve been wondering how come this possible, keep on reading Why Camino Financial Doesn’t Require Collateral for Their Business Loans? and find out about how our business loans can help you grow your company safely and steadily. You don’t have to take unnecessary risks!