Cross Collateralization: What Small Business Owners Need to Know

If you’ve ever owned a house or a car, you’re already familiar with collateralized loans, whether you realized it or not. What this means is that your bank or lender essentially owns the asset—like your house or car—that you’ve pledged to secure your loan. If you default on your loan, the lender will seize and liquidate that asset to recoup the debt. Cross-collateral loans do the same thing in practice, but alongside an already existing collateralized loan.

The lingo is commonly heard as a “second mortgage” or “putting up the car,” because that’s essentially what is happening: The lender is using an asset that’s already securing an existing loan, to secure the new loan.  If your loan is cross collateralized, there will be a cross collateralization clause in the fine print of your loan agreement.

It’s crucial that you fully understand the terms of your loan before signing on the dotted line—and that includes reading that fine print. But first, read through this primer on cross collateralization.

What Is Cross Collateralization?

A cross-collateralized loan can appear in two ways. In one instance, a single asset that’s securing an initial loan is used to secure an additional loan (or two). Alternatively, a pool of several assets can be used to secure one or more loans.

Here’s some more clarification: In the first scenario, one asset—like your home or your car—is backing multiple loans concurrently, like your mortgage and your small business loan.  As you pay down the outstanding balance on your property, you own it more and more each day. With more ownership of the item, the more bargaining power you have to put it against another cycle of debt.

The second instance of cross collateralization is when multiple assets secure one or more loans. This most often occurs when a borrower holds these loans with the same lender, because that lender can simply aggregate the borrower’s assets to collateralize all of those loans in one fell swoop.

In practice, cross collateralization might mean that if you own multiple properties, then putting up all of those properties as collateral secures a single construction loan. Or, if you hold several types of loans with the same bank—say, a car loan, a business loan, and a mortgage—then the bank might aggregate your collateral to secure all of these loans combined.

cross collateralization

Cross Collateralization vs. Collateralized Loans

Before we go further, it’s important to understand the difference between cross collateralization and regular collateralized loans. A collateralized (or secured) loan is one of the two main ways to acquire financing for your small business. The other approach is unsecured financing.

Put simply, unsecured financing allows business owners to access funding without having to put up an asset as collateral. In an unsecured loan, the business itself is the holder of the loan and not a specific item of value.

Collateralized financing, on the other hand, is always tied to an asset. Whether it’s property, a piece of equipment, a host of inventory, or any other type of collateral (and there are many), the asset is the focal point of the loan—it’s what the lender will seize and liquidate if the borrower defaults on their payments. For that reason, the asset needs to be truly valuable. In fact, the amount of money that a lender extends is based in part on the value of that asset.

Pros and Cons of Cross Collateralization

Cross-collateral loans certainly have their upsides—for one thing, secured loans in general are typically easier to qualify for than unsecured loans. But if you’re unable to pay the loan back, the consequences are very clear: The lender would simply repossess the asset—or assets—that were used to acquire the loan, and/or liquidate those assets to recoup what they’re owed.

Here are a few more pros and cons to consider about cross-collateral loans:

Benefits of Cross Collateralization

Among the benefits of cross collateralization, here is what you should consider:

Lower Cost

The most obvious benefit of a cross-collateral loan is the cost. A secured loan is always going to be cheaper than an unsecured loan because you’re trading for it. Whether it be your house, your car, or your inventory, you’re relinquishing ownership of something of equal value to the loan, then buying it back over time through your loan payments.

So, when you look at quoted rates on a cross-collateral loan, expect to see lower rates and longer terms than you would on an unsecured loan. The more valuable the asset—and the more assets you pledge—the bigger the dollar sign you can expect to see in an approval.

Easier Qualification Standards

Other than cost, the major benefit of cross collateralization is that you might have an easier time qualifying for these loans than you would for traditional business financing. Lenders have very binary and hard-set rules on what qualifies or disqualifies a business owner from receiving financing. All factors are in play, including, but not limited to, cash flow, business and personal credit scores, bank balances, industry, time in business, and many more.

With collateralized loans, so many of those stringent qualifiers fly out the window. As long as you have equity on hand, you can leverage that asset for cash. The qualifiers are more lax for these loans, because lenders are essentially holding that asset hostage to mitigate the risk of extending credit.

Leverage Your Existing Assets

Essentially, cross collateralization allows for assets tied up in existing loans to become liquid again. In other words, just because one of your assets is collateralizing a loan doesn’t mean that the value of that asset has disappeared—with a cross-collateral loan, you can leverage that value to secure multiple loans. This means your equity in assets can be turned into money once again.

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Downsides of Cross-Collateral Loans

Cross collateralization isn’t without its drawbacks. Here’s what you should know:

Greater Risk

If you were to not be able to pay this loan back to whatever bank is holding your asset, they would simply take it. This is the case for any secured loan, but if you’re pledging multiple assets to secure a loan, then of course that risk increases—not only would you lose one valuable asset but you might lose several.

Less Favorable Terms

Depending on the contract you sign, there can be difficult standards to meet all the way through your loan payment period. Especially with a second collateralized loan, the criteria becomes more strict and standards more difficult to meet. That’s because, when a lender is asked to take a second lien position behind an original loan, they are usually relinquishing some rights in case of a default. This forces them to offer less favorable terms than the first go-around.

May Affect Future Loan Decisions

When a bank or lender makes a financing decision, they carefully review the applying business’s credit score, as it’s a key factor in determining the business’s credibility. One way to boost your business credit score is by repaying your business loans in full and on time.

But if you secure one (or several) loans with assets in your personal name, then you can’t place that debt on the business. Instead, you would personally assume the debt, add to your personal debt load, and hold yourself liable to the outstanding balance.

It’s incredibly risky to bank your own home, car, or other personal asset on your business’s finances. But if your business does meet your loan repayments responsibly, you’d be missing out on a bump in your business credit score, which could increase your chances of securing an even better business loan down the line.   

Cross Collateralization: Use Cases

While cross-collateralized loans aren’t very common, there are many use cases for them. As we mentioned earlier, a real estate investor could cross collateralize multiple properties they own to secure financing for the development of those properties. This is also known as a blanket mortgage.

A consumer can cross collateralize multiple assets towards one or multiple loans. For example, if you had a car loan, credit card debt, and a personal loan from the same bank, you could pool these assets together as combined collateral for all your debts. You could do the same thing if you had multiple business loans with the same bank (such as a business credit card, line of credit, and equipment loan). In this scenario, if you default on any of the loans, collateral from the others can be seized as repayment.

One of the most common examples of cross collateralization is when you take out a second mortgage on your home. Second mortgages allow you to use the existing equity in your home as collateral for other expenses. But beware: If you default on your second mortgage you risk foreclosure on your home.

Should You Use a Cross-Collateralized Loan for Your Business?

At its best, a cross-collateral loan allows you to access equity you already own and turn it into liquid cash in the form of a loan. You work hard to pay down a loan that’s tied to a possession; it could be your car, it could be your house. The good news is that that asset isn’t completely in your lender’s possession. As you pay down your balance on that loan, you reclaim more and more of that asset. Cross collateralization allows you to dip into that available balance, so to speak, and take out another loan, right alongside the loan that valuable asset is already collateralizing.

That said, cross-collateral loans can be dangerous, because you’re risking several of your most valuable possessions for several loans. And that increases the chance of losing several assets, even if you default on just one of your loans.

So, the simple answer to “why use a cross-collateral loan?” should be that you had no other option. Maybe you were looking for more money than your business had cash flow for, or maybe the unsecured rates you were approved for were out of your price range. (And, as you recall, you might have an easier time securing a loan with a more manageable interest rate, higher amount, or securing a loan at all if you pledge multiple types of collateral.)

You’re most likely to encounter cross-collateral loans if you hold several loans with the same bank or credit union. Still, we always advise borrowers to thoroughly understand the terms of their loan before accepting any loan offer, and that’s especially important if you’re risking your own assets for that money.

Even better—avoid that risk by seeking unsecured financing, or only securing your business loan with your business’s own assets. Work with a loan specialist to help you secure the most reputable loan possible.

Former Customer Success Manager at Fundera

Forest Sisk

Forest was on the customer success team at Fundera. As a Loan Specialist, he works directly with small business owners throughout the loan process, helping them find the best financing for their companies.

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