Cross-collateralization and Cross-default Provisions in Loan Documents

By Dan Harkey, Educator, and Private Money Lending Consultant

949 533 8315 [email protected] Website www.danharkey.com

Real-life example- #20 of 25

Cross-collateralization and cross-default provisions are not just technical jargon. These terms refer to when a borrower uses more than one property as collateral for a loan and agrees to allow the lender to record a security interest document (deed of trust or mortgage) against both properties. ?The lender can declare a default on both properties if the borrower fails to meet the terms of any one loan.

“Cross-collateralization” is a strategy that allows a borrower to use multiple properties as collateral for a loan. This can be beneficial as it may increase the borrower's chances of getting approved for a loan because it increases the amount of protective equity across two or more properties. However, it's crucial to note that the risk to the borrower is significant. They could lose all their assets if they fail to meet the terms of any single loan.

A “Cross Default Provision” is a powerful tool that can work in the lender’s favor. It allows the borrower to be placed on multiple properties by default. When multiple collateral properties are encumbered, the borrower defaults on just one collateral loan. This provision is particularly beneficial when one lender has multiple loans outstanding for one borrower. It also benefits multiple collateral loans, such as a lender who loans to a borrower for real estate and a car loan.

The Loan Broker says….

Consider this scenario: my client needs a loan for $1,500,000. He's willing to pay off his first $500,000 on his home and cross-collateralize a six-unit building with adequate protective equity. This strategic move allows him to secure cash for rehabilitating the six-unit building and generating cash flow for another property.? He plans to refinance with institutional lenders upon completion and stabilization of rents.

The loan falls into the category of business purpose, which means that the borrower is using their single-family owner-occupied home and other income properties as collateral. Since the loan proceeds are primarily for business purposes, the loan does not fall into the consumer federal and state laws. This distinction is important as it affects the borrower's legal and financial obligations.

The lender will make the $1,500,000 loan, provided they encumber both properties with a cross-collateralized first deed of trust. Since there is only one first-position loan, there is no need for a cross-default provision.

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Thank You

Dan Harkey

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