What is Cross Collateralization?

Cross collateralization involves using one asset as the collateral for multiple loans. If you have an asset with enough value to secured multiple loans, then cross collateralization is an option through some lenders. 

Key Points:

• Cross collateral loans can expand your funding options: If you have a valuable asset, you can unlock more funding opportunities through cross collateralization, in this way cross collateralization is a form of asset based lending. 
• Collateralized loans have attractive interest rates: Using collateral to obtain a secured loan can help you avoid high interest rates. 
• Collateral puts your asset at risk: If you default on either of the cross collateralized loans, you could lose the asset. 

What Is Cross Collateralization?

Cross collateralization allows you to use an asset that is currently being used as collateral for an existing loan for another loan. Essentially, it means that you can take out a second loan based on the value of an asset that already has one loan tied to its value. 

Cross collateralization definition: Using an asset that is already considered collateral for another loan to secure a new loan. 

What loan types allow cross collateralization: A few types of loans that allow cross collateralization (or types of collateral for loans) include mortgages, personal loans, commercial loans, and credit cards. 

An example of cross collateralization: Taking out a second mortgage on your home is a common example of cross collateralization. Although you already have one outstanding loan based on the value of your home, a home equity loan will allow you to access more of the value in your home. 

The Benefits of Cross Collateralization

Cross collateralization is one of many financing options. As with each financing solution, there are some benefits of cross collateralization to keep in mind. 

Lower interest rates available: When you use collateral to secure a loan, you can tap into a lower interest rate than unsecured loans. This principle holds true for cross collateralized loans. 

Leverage more of your asset: Instead of allowing the value of your asset to remain untouched, a cross collateralized loan allows you to tap into the value to use now. For example, if your home has risen in value, a home equity loan allows you to use those funds now instead of waiting until after you sell the asset. 

Preserve savings: With more of your asset’s value available, you don’t have to drain your savings for an expense. 

Invest sooner: The increased access to your asset’s value means more investment capital available. 

Tax advantaged strategy: You can unlock funds through cross collateralization. With that, you can avoid selling the asset, which would create a major taxable event. 

The Drawbacks of Cross Collateralization

Of course, cross collateralization comes with some drawbacks. Here are the disadvantages you should keep in mind:

Market downturns can have big consequences: If you have leveraged too much of your asset’s value, a market downturn can be devastating. In the worst case scenario, you’ll be forced to sell the asset for less than you owe the lender. But you’ll have to make up the difference in another way to satisfy the loan. 

Asset at risk: If you aren’t able to keep up with either loan payment, the lenders can force you to sell the asset. That’s a big risk if you are putting your home on the line. 

Moving lenders is challenging: You’ll likely need to stick with one lender for all of the loans on a particular asset. 

Pros and Cons of Cross Collateralization

Need a quick recap of the pros and cons of cross collateralization? Check out the table below:

What to Know About Collateral

Before you jump into a cross collateralization loan option, here’s what you need to know about collateral. 

Collateral defined: Collateral is an asset that a borrower pledges to a particular secured loan. If the borrower doesn’t keep up with the payments, the lender has the right to sell the asset to cover their losses. 

Secured loans vs unsecured loans: The two main types of loans are unsecured vs secured loans. 

Collateral and loan types: With a secured loan, the borrower must put up collateral. With an unsecured loan, no collateral is required. 

Collateral examples: A few common collateral types include houses, cars, securities, equipment, and cash. 

Cross Collateralization Language: Loans, Clauses, Defaults

If you move forward with a cross collateralized loan, these are some terms to know. 

Blanket loan: A blanket loan is one loan that covers two or more assets. 

Dragnet clause: A dragnet clause essentially states that the collateral provided to secure one loan from a lender is also used to secure the other obligations the borrower has to that lender. For example, let’s say that you take out an auto loan with the vehicle as collateral from a bank. The same bank issues you a credit card with a dragnet clause tied to the vehicle. With that, the bank can take your vehicle if you are behind on your credit card payments, even if you are current on your auto loan payments. 

Cross-default clauses: A cross-default clause states that a borrower is in default on one loan automatically if they default on a cross collateralized loan. For example, let’s say that you have your auto loan and mortgage with the same bank. A cross-default clause would mean that if you default on your auto payment, you are automatically in default of your mortgage payment. 

Cross Collateralization and Bankruptcy

If you declare bankruptcy, cross collateralization would complicate the process. Here’s how. 

Straightforward bankruptcy: Let’s say that you have an auto loan and an unsecured credit card. In a regular bankruptcy situation, you could choose to repay the auto loan and discharge your unsecured credit card debt. 

Cross collateralization complications: Let’s say that you have an auto loan on a vehicle that is used as cross collateralization for your credit card. In this case, you would have to repay both the credit card and the auto loan to retain your vehicle.