T
here are times when a
lender is going to ask for
additional [real estate]
collateral in order to make a
borrower a loan. The most likely
scenario for this is when there is
not enough equity in the target
property. Other scenarios include
a borrower with less than stellar
credit, or the type or quality of
the target property may not be
enough to satisfy the lender to
make the loan, as most lenders
are more interested in making
loans that will pay them back
instead of facing foreclosures.
For this reason, the lender may
ask the borrower to put up
additional collateral satisfactory
to the lender so as to give the
borrower an incentive to avoid
defaulting on the loan.
In many cases, this cross
collateralization may not be
something the borrower worries
about, as the borrower intends to
pay the lender in full. The
general plan is for the borrower
to refinance the target property at
a point where a new lender does
not require cross collateralization,
pay off the existing lender, and
the existing lender releases both
properties; however, what
happens when the borrower sells
the crossed property, or has the
opportunity to refinance the
target property, and there is not
enough to pay off the current
lender who crossed?
The danger here is that the
lender may hold up the sale
because it does not want to
release their lien until they are
paid in full. For example, let’s
say the borrower owns a rental
house that is worth $500,000 and
there is a first mortgage in place
for $200,000. The borrower wants
to buy another rental for $800,000
and has $250,000 to put as a down
payment. The borrower asks a
lender to loan the remaining
needed $550,000, but the lender is
not comfortable with the LTV
[68.75%], so the lender asks what
other real estate the borrower
owns, so it can cross collateralize
its $550,000 loan. The borrower
mentions the other rental, and the
lender decides to ask for crossing
on the first rental. Thus, the lender
has lowered its risk because of the
equity in the first rental.
Now, let’s say that the borrower
receives an unsolicited offer for
the first rental of $525,000, and he
wishes to accept it. If there was no
cross collateral against this
property, the borrower could
accept the offer, pay off the
existing first of $200,000, and
pocket the $325,000 remainder.
However, because the rental has
been crossed, the lender has
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$550,000 against the property in
second position. That means that
there is technically $750,000 of
liens showing up against the
property. The borrower cannot
accept the $525,000 offer without
having the second [the crossed
loan] release its lien.
For this reason, it is imperative
for there to be an agreed upon
release price in which the lender
agrees ahead of time to release its
interest in either properties for a
specific sum. It does not
necessarily have to be just the
remaining equity in the first sale
[$325,000 in our example]. The
release price could be a smaller
amount. It could also be a larger
amount [up to what the lender is
owed]. If the lender desires more
than the $325,000, the borrower
would have to come up with
additional cash in order to transact
the sale. This may not be all bad,
as the crossed lender’s loan has
then been reduced.