Cross collateralization is a method used by lenders to add more security to a loan transaction. It is accomplished by the lender placing a lien on another property in addition to the property that is the subject of the loan. Hard money commercial lenders who want to approve a loan request may not feel that the subject property gives them enough security to approve the loan. Having more collateral reduces their position of risk.
The mortgage lender will benefit from using cross collateralization since it gives them more security for the loan being made. In the event that the borrower defaults, and a foreclosure occurs, the lender can foreclose on both properties, although this is not necessarily the lender's focus. The lender prefers that the borrower make payments, and the loan is serviced successfully until such time that the borrower pays off the loan. The borrower benefits since he is granted the loan, and can use the funds for whatever purpose he was approved for.
A cross-collateralized loan is a way for a borrower to generate funds for projects or business ventures that may not be possible with a regular banking organization. If the borrower is trying to refinance his commercial property, there may not be enough equity in the property to fill his need. With cross collateralization, the lender is able to add extra collateral to the loan, making it more desirable. If the borrower's credit rating is not as strong as a regular bank would require, the lender may require a second property as collateral due to the risk that the borrower's credit rating poses.
One definition of cross collateralization is where one property is used for security for two different loans. This would make a second mortgage on a home a cross collateral type of transaction, but is rarely explained in this way. The more common use of the term cross collateralization is the opposite of this, where two or more different properties are put up (liened) for one loan. This is also known as a blanket loan, where one loan covers several properties, and is more commonly used in commercial lending.
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The borrower needs to understand that the loan closing may become more costly to close in a cross collateralization. The lender may require an appraisal, title searches and title insurance on both properties being liened. They may require physical inspections of both properties, and there may be repairs that are required prior to closing. Another negative factor to the borrower is if he decides to sell either of the properties, they are both tied up in the liens that are created by the cross collateralized loan.
In a cross-collateralization loan, the borrower should be aware that he stands to lose both of his properties in the event he defaults on the loan agreement so putting up two properties is risky to the borrower. He must be certain that he has the means to maintain payments on this loan. A foreclosure in a dual property situation as this will show up as two foreclosures in public records, and may show up as two foreclosures on your credit report. Lastly, ask your lender about prepayment penalties. In commercial lending there may be severe penalties for paying off a loan within the first two to five years.