The right security for your loan could save your house

Given the current conditions of rising interest rates and falling house prices, I’ve been talking to clients a lot about reviewing their bank lending, with the aim of de-risking their position.

For those who have a mortgage, it involves considering whether it is structured effectively, whether the term is appropriate, ensuring they have a buffer, and considering if there are any benefits to be had by refinancing to another bank.

But there’s a bit more to consider if you own more than one property. While a property investor might be considered to be in the privileged position of being able to sell their investment in tough times if push came to shove – they can end up being the ones pushed and shoved, depending on the way their debt is secured.

Typically, debt is secured one of two ways – cross security, or separate security. Cross security just means one bank has loaned money against more than one property, whereas separate security means different banks have loaned money against different property assets.

There can be good reasons why you might have cross-secured your investment property debt – potentially your main bank offered better conditions or incentives, or was more willing to lend. But it can create problems when it comes to selling – and that is more of a risk in the current environment where property prices are weak, and interest rates are rising.

For example, you have debt cross-secured against your home and an investment property. If you decide that you want to sell your investment property to free up some cash to pay for a holiday, or surgery or to help the kids – the bank could force you to use the proceeds to reduce your home mortgage, and you end up with no cash left over.

In a more dire scenario: Say you find you can’t service all of the debt, for whatever reason. If you were to default on your investment loan and that debt is cross-secured, the bank can choose which property it wants to sell to recover its money. The bank might decide they want to sell your home, not your investment property (I’ve seen this happen) – which of course wouldn’t be your pick, but the bank holds all the cards.

When each property has its own lending, then you choose how to apply the proceeds of a sale, and if you default, that’s the only property the bank can enforce a sale on.

If your debt is cross-secured and you’re concerned, what do you do about it? Well, in the simplest of terms, you seek to release property as security, although that can be easier said than done. Your loan-tovalue (LVR) position is critical, and if it’s low enough, you may be able to refinance and, in the process, render a property freehold.

For example, say you own two properties each worth a million dollars, with debt of $500,000 cross-secured against both. You could apply to a new bank for a loan of $500,000, secured against one property, giving you a loan-tovalue ratio of 50% on that property. You’d then pay back the loan that’s secured against both, in the process releasing the other property.

Alternatively, when there isn’t enough equity to freehold one of the properties, you would again look to refinance – but this has a few fishhooks. Releasing only one of the properties would require applying to both the new and the existing bank, as your initial bank has to agree to release the security.

Even when your intention is to hold your property assets for the long haul, any number of factors can affect your ability to do that: Illhealth, the expiry of an interest-only period, redundancy – and the kind of conditions we face right now.

De-risking your lending is about protecting your options and requires considering the entirety of your financial position, including how your debt is secured – before you’re in a position where it might cause a problem. A well-thoughtout financial plan should neutralise the impact of changing conditions and, where possible, create a tailwind. With our clients, we fight for both, and I’d encourage you to do the same.