CREDIT UNIONS & CROSS COLLATERALIZATION CLAUSES
Around here, we have an awful lot of hometown credit unions. Credit unions often offer lower interest rates on loans and other benefits for their members. I have been a member of a local credit union most of my life but until I started practicing bankruptcy law, I never knew about “cross-collateralization” or even imagined that it was something commonly done at credit unions & banks. This issue pops up rather regularly and when a person is considering bankruptcy, they should know about what may happen before they file.
What in the world is “cross-collateralization”?
A cross-collateralized loan is where one piece of collateral secures more than one loan. Credit unions often cross-collateralize credit card and signature loans with car loans, which can be disastrous for the borrower. Often these clauses will be in a “LoanLiner” credit contract and people just don’t realize what that means. Well, what does it mean?
The easiest way to explain it is through the following example:
Everyone knows that if you buy a car with a loan, the lender has a lien against the car to secure the payment. The lien allows the creditor to repossess the car if the borrower does not make all of the payments. A cross-collateralization agreement allows the lien against the collateral (the car) to secure additional debts other than the car loan. This means that if you don’t pay a credit card that is cross-collateralized with your car, then the creditor can repossess your car. This is true even if you are current on the car loan!
Very few people who sign cross collateralization agreements realize that they are agreeing to this sort of treatment. The contract language that creates the cross-collateralization is often buried deep in the fine print, and it is not obvious when you are signing the financing agreement. Credit Unions almost always have cross-collateralization agreements. Be careful if they ask you to sign something called a loan liner agreement, this will cross-collateralize your debts.
HOW DO YOU PROTECT YOURSELF FROM CROSS-COLLATERALIZED CAR LOANS?
The best way is to make sure not to take out credit cards or signature loans from the same lender that gave you the car loan. Make sure not to have any other loans from the bank where you have your car loan. Banks won’t cross-collateralize the loans of other banks, so this way you are safe. You should also avoid having more than one loan at a credit union. Credit unions almost always have borrowers sign cross-collateralization agreements. They like to put your car at risk to make sure that they get paid on risky loans like credit cards and signature loans.
HOW DO CROSS-COLLATERALIZED CAR LOANS WORK IN BANKRUPTCY?
If you file for bankruptcy when you have a cross-collateralized loan, you have two choices on what to do with the collateral:
1. Reaffirm all of the loans that are secured by the collateral and continue making payments after the bankruptcy until they are all paid off. This allows you to keep the collateral, but means that you will have to pay off debts that would be dischargeable in bankruptcy if there were no cross-collateralization agreement.
This also means that you could be paying double or more for the car (collateral) loan if you owe quite a bit on your credit union credit card or loan. For example: You financed a car for $10,000.00. You paid on the car several years and now the loan balance is $5000.00. Since the car is several years old, the resale value of the care is only $3000.00 so you are underwater on the car loan. You also have a credit card with the same credit union and the balance is $6000.00. If you file for bankruptcy and want to keep the car, then the credit union will want you to “re-affirm” the debt but you would owe them $5000 for the remaining car loan PLUS $6000 for the credit union for a total of $11000.00. The car became collateral for the credit card. If you did not have the car loan with the credit union, the $6000.00 credit card balance would be dischargeable in bankruptcy as a non-priority unsecured debt.
2. Surrender the collateral. If you simply surrender the collateral and allow the bank to repossess it, then you will have no more debts at the end of the bankruptcy. Unfortunately, you will also lose the collateral. This is probably the better option if the loans secured by the collateral are worth much more than the collateral.
I hope this was helpful.
If you have any questions about bankruptcy, please feel free to contact me. Consultations are always free.