It's common knowledge that if you don't pay your mortgage, the mortgage lender has the right to foreclose on the property in order to recoup their money. However, what if you didn't pay your mortgage and your mortgage lender had the ability to repossess your car? Or simply withdraw the payments from your checking account or charge them to your credit card? This is the basic idea behind cross- collateral loans, or cross-collateralization.
In this article, we'll take a closer look at what this term means, where you're likely to encounter it in practice, and the pros and cons of cross-collateralization for borrowers and lenders.
What is a cross-collateral loan?
The simple definition is a cross-collateral loan (also simply referred to as cross-collateralization) refers to the practice of assets represented by one loan being used to simultaneously secure another loan.
For example, let's say you have an auto loan and a mortgage, both held by the same lender. A cross-collateralization clause would mean that if you stopped making your payments on the mortgage, the lender could choose to go after the car, or vice versa.
It's important to note that cross-collateralization doesn't just have to do with loans. Let's say you have a certificate of deposit (CD) account and an auto loan with the same financial institution. If you stop paying your auto loan, the bank could choose to withdraw from or freeze access to your CD until your loan is made current. The same could be said if you have a credit card at the same bank where you have a loan account.
In practice, the most common place you'll find cross-collateralization is at credit unions. Credit unions are well known for offering favorable loan terms to borrowers -- and reducing their potential loss exposure through cross-collateralization is one way they're able to do it.
In real estate situations, cross-collateralization is most common in construction loans, which are generally seen as risker to lenders than simple purchase mortgages. (After all, there's quite a bit that can go wrong with new construction, and budgets are forced to be stretched all the time.) So, if you're an investor who owns multiple rental properties, and you apply for construction financing, don't be surprised if the lender asks you to pledge at least one of your other properties as collateral.