Many choose credit unions because they generally offer certain advantages over banks. You might get a better interest rate on a loan, a higher credit limit, fewer fees, or more personalized attention. But credit unions also commonly practice cross-collateralization—a term most have never heard of and rarely pay attention to when scanning the fine print.
Secured vs. Unsecured Loans
Borrowing money to purchase something of value, like a car, boat, or home requires a measure of security for the lender. The property you buy is used as collateral so if you don’t make your loan payments, the lender can take the item, sell it and pay off the debt. This is referred to as a secured loan. In contrast, an unsecured loan is collateral-free lending supported only by the borrower’s creditworthiness.
Cross-collateralization simply means using the collateral for one loan on another loan. How can this happen? When you borrow money from a credit union to purchase something, the loan contract might include a clause that says not only is the asset the collateral for the loan you just procured to buy it, but it will also be the collateral for any other loans you take out through the credit union—including credit cards and personal loans.
Walk Me Through This
You take out a loan to buy a car from your credit union, and the loan has a cross-collateralization clause in it. You later open a credit card account with the same credit union and max out the credit line. Time passes, you pay off the car, but you still have a balance due on the credit card. If you can’t make payments on the credit card at any time, the credit union can repossess your car and sell it to satisfy the credit card debt.
How Does Cross-Collateralization Affect a Bankruptcy?
You’re obligated to repay secured loans if you want to keep the property securing the loans when you file bankruptcy. For example, if you owe money on your car, you must pay back the loan if you want to keep your car when you file. At the same time, depending on which chapter you file, unsecured debts can be wiped out completely—a favorable advantage of bankruptcy.
But cross-collateralization is a circumstance where debts you think are unsecured might actually end up secured. And in those cases, discharge of the debt isn’t an option without returning the collateral. Instead, you must pay the balance of the unsecured loan to keep the collateral.
In a Nutshell
If you have loans or debt with a credit union, it’s important to be mindful of the potential for cross-collateralization when you file bankruptcy. Anticipating a discharge of debt on your unsecured loans while keeping all your property may not be an option if your credit union has a cross-collateralization clause in the contract.
For people struggling with debt, there are many options. If you find yourself in an unmanageable situation, the right option will depend on several factors. The advice of an experienced bankruptcy attorney is essential to determine the best course to take.
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