Cross-collateralization loans and the rights of a credit union
Recently on our bankruptcy forum a user asked, “I have an unpaid, unsecured, personal loan through a union. I also have a car loan with the same credit union. I found out that the credit union has placed a lien on my car. They described this as cross-collateralization. What does this mean and is it legal?”
What this debtor describes is known as cross-collateralization. Cross-collateralization allows the lender to use the first loan, and the assets attached to the loan, as collateral for the second loan. So in this instance, the credit union has placed a lien against the debtor’s car for a personal loan which, under normal conditions, would have generally been considered an unsecured loan.
Unfortunately, this is legal and is one of the reasons some financial experts warn against using credit unions for all of your lending needs, especially given the more aggressive nature of their tendency to use cross-collateralization clauses within their lending contracts.
Downside of cross-collateralization
Although the credit union likes to use cross-collateralization to ensure debt repayment, thus lowering their risk of lending money, this practice is not good for the borrower. In fact, not only is this practice generally not explained before a borrower signs a contract, it essentially changes unsecured debt to secured debts and allows liens to be placed on secured property if those debts are not paid.
This can be especially harmful if a debtor decides to file bankruptcy. Now, debts that would have otherwise been fully dischargeable, such as the personal loan described above, are “secured” by the car- although the debts themselves can still be discharged in bankruptcy.
If the debtor files Chapter 7 bankruptcy the most likely outcome is the personal loan is discharged, but the creditor places a lien on the car for the cross-collateralized, unpaid, personal loan.
Eventually the debtor, who was able to keep the car and continued to make car payments, will pay off the car loan and will want to sell the car. The Credit Union, however, will tell him that although the car loan is fully paid, there is a lien against the car for the personal loan that was not paid. The credit union will refuse to release the title to the debtor who will then be unable to sell the car.
Options for a cross-collateralized loan
The best option for most borrowers is to avoid a cross-collateralized loan. This can be done by fully reviewing all contracts prior to signing them. Borrowers may also want to consider getting different loans from different lenders.
If you already have a cross-collateralized loan, however, and you are considering filing bankruptcy, you can talk to a lawyer about your options. Options may include signing a reaffirmation agreement and voiding the collateralization clause for the installment loan, filing Chapter 13 bankruptcy and determining if the car is eligible for a cram-down, or surrendering the car back to the credit union, which will allow all credit cards and installment loans to be fully discharged without creating a lien against the car.