The Cross Collateral Risk
Cross collateral is where a lender takes security over a number of assets to secure their line of credit, risk, mortgage or loan.
One of the more surprising elements of cross-collateralisation is that borrowers can find themselves within that situation unintentionally. It is common to see a bank lend against a property, what many borrowers won’t realise is that most banks take an ‘all monies’ charge which means that security will secure any exposure the bank has, be it overdraft, another loan or a different line of credit.
In short, cross-collateralisation is great for the lender. What is strange is that many borrowers see cross collateralisation as a benefit whereas it should, maybe, be considered a risk.
Why does this happen?
The most common reason borrowers get into this situation is by approaching the same lender time and again, believing it to be the easiest and quickest way to raise finance. Hence, why some borrowers see cross-collateralisation as a benefit.
The problem is, when it goes wrong. It goes wrong.
When it goes wrong
Remember 2008? Some will, some won’t. I remember it well, it was not a good time to be working in finance. At the time I was working for a major UK bank, so these views are based on real experience:
If all your lending is with one lender, if one asset depreciates in value, then that lender has control over all your assets. One bad asset means you could lose all of assets the lender has a lien over.
Add to this:
- If a lender changes their criteria or policy you are stuck and that lender has all the power and all the control. Through no action of your own you are totally exposed
- Any increase to that lender’s interest rates are applied across all your borrowing with them
- Releasing equity or refinancing is more difficult. All your assets secure all your borrowing, the lender has control over what they will or won’t release and at what price
The simpler risk is that using the same lender on every finance deal eliminates every other lender on the market.
- Lenders change their minds and policies. Too much exposure in one area and they will curtail lending to that sector, it could be you
- There can be better costs, better terms and better options. Stay nimble, stay flexible
I saw the impact of having all your eggs in one basket in 2008, I saw businesses hurt by it. There are parallels with 2008 now, it is a different world but when rates rise and defaults increase lenders change policy and curtail lending quickly and without warning.
Keep your options open. Multiple buyer and multiple suppliers. It is basic Porter modelling and it still stands.
By Dave Farmer