Today, we'll look at a topic many people are dealing with: using a second property as collateral for a bank. How risky is it? How long does the property have to remain as collateral, and how can you explain the whole situation to someone willing to offer their property, such as your parents?
In a previous article, I discussed how to finance the entire purchase price of a property with a mortgage without any of your own funds. And the most common solution is exactly this: to offer the bank a second property as collateral in addition to the one you're buying. This provides the bank with a higher total collateral value, allowing you to finance 100% of the purchase and sometimes even a little extra, for things like furniture or other furnishings.
But as soon as you bring up this topic, a lot of questions arise. People want to know if it's worth it for them, and they also need answers for the person who might provide the property. So, let's go through the most common questions.
What Value Must the Collateral Property Have?
The answer is actually quite simple. It needs to cover what you're missing or don't want to pay from your own funds. Let me show you with an example.
Imagine you want to buy a property for 10 million crowns and don't want to put down a single crown of your own money. This means that the 10 million must represent a maximum of 80% of the total collateral value (the LTV – loan to value). The calculation is simple:
You take 10 million, divide it by 0.8 (or divide by 80 and multiply by 100), and you get the figure of 12.5 million crowns. This is the minimum total value of all properties that will be used as collateral.
Now, let's assume the appraisal of the property you're buying comes out to 10 million. It's not a guarantee, but it's likely to match the purchase price. So, we already have 10 million of the 12.5 million covered, and we just need to find the remaining 2.5 million. And that is the minimum value of the second property you need to provide to the bank. So, if your parents have an apartment valued at 2.5 million or more, it can be used, allowing you to finance the ten-million-crown apartment without any of your own money.
If you are under 36 or if the bank grants an exception, you can go up to a 90% LTV. This changes the situation, as you would then calculate 10 million divided by 0.9, which comes out to just over 11 million. In that case, you would only need a second property valued at slightly over 1 million CZK.
You can use the same calculation in other situations. For example, if you want to finance 9.5 million and have 500,000 of your own funds, you just take 9.5 million, divide it by 0.8, and you'll immediately see what the total collateral value needs to be.
What Restrictions Come with Parents Putting Up Their Property as Collateral?
For the bank, the property is simply a guarantee that you will repay the loan. If you were to stop paying the mortgage, the bank would primarily seek to satisfy the debt from the sale of your property, but it's good to know that legally, there is no difference between the properties used as collateral.
I know, it sounds quite scary, but this is really just an extreme case. The bank resorts to selling a property only in very rare cases. Before something like that happens, they first offer payment deferrals, a temporary reduction in payments, an adjustment to the payment schedule, and finally, the option to sell the property yourself to avoid foreclosure or auction. The bank doesn't want to seize properties, and believe me, you don't want to let things get that far. If you know there might be a problem with payments, it's always better to act early.
What other restrictions does a lien entail?
- The property cannot be sold without paying off a portion of the mortgage so that the remaining balance is covered solely by the property that remains as collateral.
- If you want to undertake major structural modifications or renovations, you must report it to the bank. This is because if someone guts the property down to the brick and runs out of money, the collateral value temporarily decreases, and the bank wants to prevent that.
How Long Will the Second Property Have to Be Used as Collateral?
Here's some relatively good news: it's extremely unlikely that it will be held for the entire mortgage term. Usually, it's for about five years at most, and often less. Why? There are two effects working in your favor:
- You are paying down the mortgage, which reduces your debt.
- The value of your property increases over time.
Together, this means that you can sometimes have the second property "released" after just two years. The process is quite simple. You ask the bank to reappraise the property that will remain as collateral (the one you bought). And if, after two or three years, the bank appraises it at, say, the 12.5 million from our example, the second property is no longer needed as collateral, and the bank will be willing to release it.
What If, for Example, Your Parents Change Their Minds?
That sometimes happens, and there's often an immediate solution. You can take out an unsecured loan (e.g., a loan from a building society), make an extra payment on your mortgage, and thus reduce its balance. This will bring you within the collateral requirements for just the one property, and the second one can be released.
Of course, this will increase your monthly financial burden, as an unsecured loan typically has a shorter repayment period and a higher payment. It's not ideal, but if your parents have changed their minds or need to sell their property, it's a viable solution. And you can do this even just a few months after taking out the mortgage.
