Cross collateralization: What it is, how it works and key risks

This resource is intended for informational purposes only. Nav does not provide legal, tax or financial advice. If you have any questions or concerns, please consult with your own legal and accounting professionals.

When applying for business financing, you may be asked to put up an asset as collateral to reduce your lender’s risk. If you default on the loan, the lender may be able to seize that asset to offset their financial loss. 

In some cases, your collateral arrangement may be more complicated than simply pledging one asset for a single loan. That’s where cross collateralization comes in. 

Cross collateralization allows business lenders to use your existing asset to secure multiple loans, or use multiple assets to secure a single loan. While you may qualify for better financing or loan terms with cross collateralization, it can also put more of your assets at risk and limit your future borrowing options. 

Before signing any agreement with a cross collateralization clause, it's important to understand how cross collateralization works, when lenders may push for this clause, and what could happen to your business if things don't go as planned.

What is cross collateralization? 

Understanding collateral

It’s helpful to understand collateral before discussing cross collateralization. Collateral is something of value, such as cash, equipment, inventory, or real estate, that a lender can claim if you don't repay a loan. Loans that require collateral are called secured loans, while unsecured loans don't require any assets.

If you’re taking out a business loan, business lenders may demand your business assets, the item you're financing, such as equipment or machinery, or even your personal assets as collateral.

Cross collateralization explained

Cross collateralization is a more complicated version of collateral that allows one asset to be used as security for multiple loans. A cross collateralization clause is the provision in a loan agreement that gives the lender the right to seize your collateral asset(s) if you don’t pay what you owe on time. 

A second mortgage is an easy example of cross collateralization in personal finance. When you place a second mortgage on your home, you risk losing the property if you default on either mortgage. 

How cross collateralization works

Cross collateralization creates a legal connection between your loans and your collateral. Rather than treating each loan independently, your lender views the pledged assets as security for multiple financial obligations. This can be risky for you, because one missed payment on any loan can put several — or all — of your assets at risk. 

Cross collateralization typically happens in one of two ways: When you use one asset to secure multiple loans, or when you use multiple assets to secure a single loan. 

Using one asset to secure multiple loans

This is the form most commonly associated with a cross collateralization loan.

Let’s say you use your company’s warehouse, which has a value of $750,000, to secure:

• A $300,000 equipment loan
• A $150,000 line of credit
• A $100,000 expansion loan

The warehouse serves as collateral for all three debts. Your lender may be able to seize it if you default on either loan or the line of credit.

Cross default provisions

Many agreements also include a cross default provision, which means that defaulting on one loan can trigger a default on the others. 

For instance, in the multiple-loan example above, your lender may be able to declare all of your loans in default if you miss a payment on your line of credit, even if payments on the other loans are current.

Pledging multiple assets for one loan

Alternatively, you can use several assets to secure a single loan. This form of cross collateralization structure may allow you to qualify for a larger loan amount because the lender has more security.

For example, let’s say your manufacturing company applies for a $500,000 working capital loan. The lender requires collateral, but you don’t want to risk your warehouse itself. Instead, you secure the working capital loan using:

• Your business equipment valued at $250,000
• Inventory valued at $200,000
• Accounts receivable valued at $100,000

The lender has claims against all of these assets until the debt is repaid.

How does cross collateralization impact borrowers?

If you make all of your loan payments in full and on time, having cross collateral will not impact you at all. But if you default on one loan, you may be considered to have defaulted on all loans, since that asset or assets would then be seized, and lenders will have to fight to get a piece of the value.

Here’s a tangible example. Let’s say you own a business called ABC Manufacturing with the following assets and loans: 

Assets:

• Commercial building: $1 million
• Machinery: $300,000

Loans:

• Equipment loan: $200,000
• Working capital loan: $150,000

Your lender inserted a cross collateralization clause in both loan agreements. As a result, your building secures both loans, and your equipment also secures both loans.

If ABC Manufacturing defaults on the $150,000 working capital loan, your lender may have the right to seize and liquidate both the building and the equipment to satisfy the debt.

Without cross collateralization, only the collateral specifically tied to the defaulted loan would typically be at risk. So if your commercial building secured your working capital loan and your machinery secured the equipment loan, your building will not be at risk if you defaulted on the equipment loan. 

Pros and cons of cross collateralization

If you don’t qualify for the best business loans, a cross collateralization loan can be appealing because as a way to secure affordable financing. 

However, a cross collateralized loan can be risky. If you can’t afford to pay one of your loans, you risk losing all your assets that you used as collateral. 

Pro: May qualify for larger loan amounts

Additional collateral reduces lender risk. In turn, you may be offered the option of taking out more money.

Pro: Potentially lower interest rates

Since your lender has stronger security, you may also be offered lower interest rates than you would get through unsecured financing.

Pro: Easier approval with weaker credit

Businesses with limited credit history or lower credit scores may have an easier time qualifying for loans if they agree to cross collateralization.

Pro: Builds lender relationship

Working closely with one lender may lead to additional financing opportunities in the future.

Con: Risk losing multiple assets if you default

A single payment default may put several of your valuable assets at risk rather than just one.

Con: Complicates selling or refinancing assets

You typically can't sell or refinance collateralized property without your lender’s approval, which can tie up your resources. Furthermore, your collateral may depreciate if damaged or destroyed, so you may be required to take out insurance if you don’t already hold a policy for the asset in question.

Con: May trigger cross-default on all loans

One missed payment can affect multiple debt obligations due to a cross default provision.

Con: Less flexibility for future borrowing

Any assets you have already pledged in prior agreements may not be available for you to use as collateral for financing from a different lender.

Cross collateralization in real estate

Cross collateralization is especially common in commercial real estate and investment property lending. 

Cross collateralization for commercial mortgages

Business owners sometimes use real estate equity to secure business loans.

For example, a lender may allow you to use equity in a commercial property or even a personal residence to secure both a mortgage and a business loan. 

While doing so can help you access additional financing, it also increases the stakes significantly because the same property is backing multiple debts. 

And if you default on your business loan, your lender may be able to foreclose on your home — even if you're current on your mortgage payments, and even if that business lender doesn't hold the first lien on the property.

Before using real estate as collateral, make sure you understand exactly which properties are pledged, and under what circumstances the lender can take action.

Blanket mortgages for real estate investors

A blanket lien, or blanket mortgage, allows multiple properties to secure a single loan. Real estate investors often use this structure when purchasing or refinancing a portfolio of properties.

Some lenders may allow you to sell or refinance individual properties as you build additional equity in the remaining collateral.

If you’re seeking a blanket mortgage as a developer of an investment property, make sure you secure a release clause in your cross collateralization agreement. This will allow individual properties to be removed from the blanket mortgage after certain conditions are met. Without a release clause, it’s much more difficult to sell a property tied to a cross collateralization loan.

Cross collateralization and credit unions

Cross collateralization is also very common among credit unions, many of which include broad cross collateralization language in membership agreements and loan documents. 

As a result, collateral you pledge for one loan may automatically secure future loans with the same institution. For example, a vehicle securing an auto loan could potentially become collateral for a personal loan or business loan obtained later.

Before signing any loan documents, keep an eye out for language like:

• "Secures all present and future obligations"
• "All debts owed to the credit union"
• "Future advances clause"
• "Cross-collateral provision"

Any of these phrases are an indication that your assets may be at risk in the event of default. 

Questions to ask before signing

Before signing any loan with a cross collateralization clause, make sure to ask the following questions and get satisfactory answers: 

• Does this collateral secure only this loan?
• Does it secure future loans as well?
• Is there a cross default provision?
• Can collateral be released after a certain balance is paid?
• What happens if I refinance with another lender?
• Can personal assets become collateral for business debt?

Cross collateralization and bankruptcy

No business wants to go bankrupt. But if you ever need to file for bankruptcy, cross collateralization can complicate those proceedings since multiple loans may be tied to the same collateral. 

If you are in this situation, it is strongly advisable to speak with a bankruptcy attorney regarding the specifics of your loans and cross collateralization for guidance on next steps. 

Chapter 7 bankruptcy: Liquidation

In a Chapter 7 bankruptcy, your business assets may need to be liquidated to repay your creditors. Cross-collateralized assets can result in disputes over how proceeds are allocated among your various financial obligations. 

Chapter 11 bankruptcy: Reorganization

When you file for Chapter 11 bankruptcy, you are making an effort to reorganize your debts while continuing business operations. Existing cross-collateral agreements may impact your negotiations with various lenders and limit your restructuring options.

Bankruptcy laws are complex, and the outcome depends on the specific loan agreements and circumstances involved. If your business is experiencing financial distress and has cross-collateralized debt, consult a qualified bankruptcy attorney as early as possible.

How to avoid cross collateralization problems

Cross collateralization isn't always bad, but it's important to manage the risks. The following steps can protect you before you agree to any cross collateralized loan:

Read all loan documents carefully

Cross collateralization clauses are easy to bury in the fine print of lengthy loan agreements.

Ask specifically about cross-collateral clauses

Don't assume collateral only secures the loan you're applying for.

Negotiate removal of cross-collateral provisions

Some lenders may be willing to modify or remove these clauses, especially for strong borrowers.

Shop around for alternative financing

You may find lenders that don't require cross collateralization.

Work with different lenders for different loans

Using multiple lenders can help prevent one institution from controlling all of your collateral.

Alternatives to cross collateral loans

Depending on your business's needs, other financing options may offer greater flexibility.

Unsecured business loans

A standard, unsecured business loan does not require any collateral. However, your interest rates may be higher than what you pay on a loan secured through cross collateralization.

SBA loans

Some SBA loans backed by a government guaranty require collateral when available. But lending structures vary based on the loan amount and many other factors. In many cases, SBA loans offer more borrower-friendly terms than you’ll find through a private financial institution.

Business lines of credit and credit cards

Business lines of credit  and business credit cards can be useful for financing your ongoing needs for working capital needs, and may not require extensive collateral. On the flip side, you may end up paying higher rates of interest if you don’t pay back what you owe before the deadline.

Revenue-based financing

Some lenders focus on cash flow rather than pledged assets. If your business has high revenue, especially consistently recurring revenue, you may be able to secure financing without putting up your assets as collateral. 

Is a cross collateral loan right for your business?

Cross collateralization can help you access funding for which you might not otherwise qualify. It can provide lower interest rates and larger loan amounts.

However, those benefits come with meaningful risks. A single default could place multiple assets in jeopardy. Any non-payment can also reduce your future borrowing flexibility, and complicate refinancing or asset sales.

Before agreeing to a cross collateralization clause, ask yourself:

• Do I fully understand which assets are at risk?
• Can my business comfortably make the required payments?
• Will I need these assets as collateral for future financing?
• Am I comfortable with potential cross-default provisions?
• Have I compared alternative financing options?

If the answer to any of these questions is no, it may be worth exploring other financing structures before moving forward.

Frequently asked questions