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What Are Cross-Collateralized Loans & How Do They Work?

Cross-Collateral Loans - How They Work
Austin Kilham
Austin KilhamUpdated September 2, 2022
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In the fine print of your loan agreement may be what is known as a cross collateralization loan clause. These clauses provide lenders with a way to secure money you’ve borrowed from them, and they can have big implications for your finances. It’s critical for borrowers to understand cross collateral loans so they’re not caught off guard. Here’s what you need to know.

What Does Cross Collateralization Mean?

Cross collateralization is when a lender uses one asset to secure two different loans. For example, your car could be the collateral to secure an auto loan, and then also be used to secure a second loan you take out with that lender. Cross collateralization may be used for a variety of loans, including mortgage loans, personal loans, auto loans, and credit card debt.  Recommended: What Can and Can’t Be Used as Collateral

How Cross-Collateralized Loans Work

A secured loan is one that is backed by collateral, which is an asset like a house or car. If a borrower fails to pay back their loan, their lender can seize the collateral and sell it to recoup some of their losses. With cross-collateralized loans, even if you pay off the first loan, the collateral for that loan is still used to secure the second. Fail to pay off the second loan, and you could lose your property. 

Pros and Cons of Cross-Collateralized Loans

While cross collateralized loans can be complicated, there are a variety of benefits borrowers can reap from the process. For example, it allows borrowers to use existing assets to finance new loans. For instance, your house, which is the collateral for your mortgage, could also be used as the collateral for an auto loanWhat’s more, it may be easier for borrowers with poor credit to qualify for a cross-collateralized loan. Borrowers may also end up with better interest rates since the loan is secured. Finally, it’s possible that fees and transaction costs might be kept to a minimum since both loans are held by the same financial institution. That said, there are drawbacks to consider with cross collateral loans. For one, borrowers will have to keep up with two loans at once, or risk losing their property. This could have serious ramifications, especially if both loans are secured by a borrower’s primary residence, for example. You may also lose a certain amount of freedom when it comes to what you can do with the assets you’ve pledged. For example, say you use your car as cross collateralization for a personal loan. You finish paying it off and want to sell it. You may not be able to do so until you also finish paying off the personal loan. Here’s a look at the pros and cons of cross collateralization to help compare them:
Allows financing using existing assets.Increases borrower’s debt burden.
May be an easier way for borrowers with poor credit to secure a loan.Increased risk that property will be seized if the borrower can’t keep up with both loans.

Cross Collateralization and Bankruptcy

When you have a secured loan and you file for Chapter 7 bankruptcy, you have to pay off that loan if you want to keep your property. For instance, say you have an auto loan and personal loan through your lender that both use your car as collateral. If you file for bankruptcy, you will have to pay off both of those loans if you want to keep your car.  Typically speaking, unsecured loans are dischargeable, meaning the debt is canceled, in bankruptcy proceedings. 

Cross-Collateral Loans in Mortgage Lending

Cross collateralization can be used in mortgage lending. For example, a borrower with a mortgage on their primary residence might use their home as collateral to buy an investment property. The loan is then secured by both the investment property and the borrower’s home, which may be viewed more favorably by lenders since there are essentially two properties securing the loan against default. This extra security could mean that the borrower is more likely to get the loan on the second property approved, and they might receive a better offer for terms and interest rate. Recommended: Mortgages vs Personal Loans

Alternatives to Cross-Collateralized Loans

Cross collateralization is not always necessary for those seeking loans. Here’s a look at some alternatives. 

Unsecured Personal Loans

Most personal loans are unsecured — they don’t require collateral. With these loans, banks, credit unions, and online lenders will offer a loan amount, which borrowers agree to repay at regular intervals with interest. A borrower’s ability to qualify for loans and receive the lowest interest rates will depend largely on their credit history and credit score. Those with higher scores tend to qualify for loans with the most favorable interest rates. Because borrowers with lower scores are seen by lenders as more likely to default on their loans, lenders tend to offer higher interest rates to those borrowers. 

Secured Personal Loans

Secured personal loans, on the other hand, do require collateral. For example, a borrower could put up the cash in their savings account, a car, or even their home to back a personal loan. It may be easier for borrowers with poor credit to qualify for secured loans and receive lower interest rates. 

Joint Personal Loans

If you’re applying for a personal loan as a duo, you may consider a joint personal loan. These loans involve two borrowers who are equally responsible for the loan. When applying for a joint personal loan, your lender will look at both applicants' credit histories. Both of you will have equal rights to the loan funds.Joint borrowers are not the same as cosigners on personal loans, who take responsibility for paying off the loan, but do not have access to loan funds. 

Home Equity Line of Credit

A home equity line of credit, or HELOC, is a form of revolving credit that uses your home as collateral. You can borrow up to a certain credit limit, which is restored as you repay your debt. It’s important to be careful with loans that use your home as collateral. Default on them and you could find yourself without a place to live. 

Compare Personal Loan Rates With Lantern

If you’re in the market for a personal loan, you’ll want to shop around for one that will provide you with the lowest interest rate and terms to meet your needs. Lantern by SoFi can help you compare loan rates and apply for personal loan rates in minutes.

Frequently Asked Questions

Is cross-collateralization bad?
Can you get out of cross collateralization?
Is cross collateralization legal?
Photo credit: iStock/Nuthawut Somsuk

About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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