Cross-Collateralization
Cross-collateralization occurs when the collateral, or property used as security against a loan and forfeited if the loan is not repaid, for one loan is served as a collateral for another loan. An example can be seen when a homeowner, whose home has gained value of their home equity over the years, wants to buy a second home. The person can use the equity from the existing house as collateral for a loan on the second house. So the collateral for one loan is crossed over to another loan, hence the name cross-collateralization.
Cross-collateralization is related to another term “Loan to Value,” or LTV. The LTV is the amount that is still owed on the mortgage. For instance, if the value of the house is $500,000 with the remaining debt of $200,000, the LTV is 40%. In other words, the owner is borrowing 40% of the property value. Some, and sometimes all, of the remaining value can be used as collateral for a different loan.
When the bank approves a cross-collateralization, it will issue what’s called an equity loan to the borrower. Equity loan is sometimes called by different names such as home-equity loan, second mortgage or home equity line of credit (HELOC). An equity loan is a loan or line of credit secured by your home. The lender allows you to use the equity, or the difference between the market value of your home and the amount you owe, as collateral for your second loan.
The repayment period for a second mortgage or home-equity loan is usually set up to be half the length of your first mortgage loan. For instance, you are set up to pay off your first mortgage in 30 years. On your equity, you will have 15 years to pay off. However, that is not a hard and fast rule. Sometimes, the payment period for a home-equity can be as soon as 1 year to 30 year like on your first loan, depending upon your lender. The interest rate for your home-equity loan is usually adjustable rather than fixed, and it is also usually lower than the rate for standard loans or credit cards.
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