Investment Finance

The Bank’s Secret Weapon

Friday, May 28th, 2010

Property investors Gordon and Sally Jones are about to lose everything, their home, their three investment properties, and potentially their marriage; if only they’d been advised on how to protect their home from the bank when they set their loan up.

You see, their bank, like all lenders, has an insidious ‘secret weapon’ embedded in their legal documents, it’s called the “All Monies Mortgage Clause” (AMMC) and it puts them in a commanding position.

So how did Gordon and Sally get themselves into this position?

Years ago, Gordon got a loan from his local bank manager to buy his own home.  About five years ago, after marrying Sally, they decided to buy some investment properties. So, like most property investors, they went back to their bank manager who happily arranged a loan for “106% of the purchase price” for each of the properties, to cover costs and deposits.

“Fantastic”, they thought, “Just like we heard at all those seminars – build a property empire using none of your own money!”

After hearing about the dangers of cross collateralisation from a mate, Gordon insisted on each loan being “stand-alone” and his bank manager happily obliged.

What Gordon didn’t know was that cross collateralisation was to be the least of his worries. It was the AMMC that was to be his downfall.   His unawareness sowed the seed for today’s catastrophe.

Let’s look at how his bank manager explained the setup of his loans

You might be thinking that this all looks fine – so where is the problem?

The AMMC threat is subtle and poses no immediate threat; the menace can lay dormant for years, but it does give the bank the means to foreclose almost at will.

Real finance structuring tactics

The way in which their bank structured their loans is actually quite different from the structure illustrated in the first diagram above.

In reality, the bank, which already held the title to Gordon’s home, had simply thrown a net around his home and their investment properties to ‘jointly and severally’ secure the total debt.  That’s right: the bank now has the right under the AMMC to foreclose on any or all of the properties to repay all loans.

The bank has actually ‘stripped’ equity from their family home and applied it to the purchase of their investment properties in what is known as an ‘equity transfer’.

Equity transfers are standard banking practice and have enabled mum and dad investors across the country to build a property portfolio, but it has also exposed them to unnecessary dangers.

More about that and how to avoid the traps later…