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Beware of Cross-Collateralization when dealing with Credit Unions

Credit Unions are financial institutions that function a lot like banks but are regulated differently because of their not-for-profit status. Credit Unions generally offer great rates and terms for their members; when it comes to mortgages, car loans, and even credit cards. However, when you take out a secured loan with a Credit Union (i.e., a car loan), the Credit Union will probably include a cross-collateralization clause somewhere in the loan agreement.

In the example of a car loan, a cross-collateralization clause makes the collateral that secures the car loan (the car) serve as collateral for all loans the credit union has made or will make to you. This transforms any unsecured debts that you have with that credit union (i.e., a credit card) into secured debt. It is often the case that the debtor has no idea that this cross-collateralization exists. That is until after default or during bankruptcy.

Cross-collateralization and Chapter 7 Bankruptcy

What effect does the cross-collateralization have on a Chapter 7 Bankruptcy filing? If you signed a loan agreement with a cross-collateralization clause and then filed Chapter 7 Bankruptcy, the unsecured debt that is cross-collateralized will not be dischargeable. This is unless you surrender the collateral (i.e., the car). Alternatively, you may “reaffirm” all of your debts with the Credit Union (agree to pay them back after bankruptcy). Or, “redeem” the car by paying the trustee the current market value of the car in one lump sum payment.

Chapter 13 Bankruptcy

What about Chapter 13 Bankruptcy? Under the Federal Bankruptcy Code, Chapter 13 Bankruptcy contains a provision. It allows you to “cram-down” secured loans to the value of the collateral. This allows you to restructure the secured debt to pay only up to the value of the vehicle at the time of filing.

For example, pretend that the balance on your credit union car loan is $15,000. And, you owe another $10,000 in credit card debt to the same credit union. That means you owe the credit union $25,000 for the car. If the car is worth $10,000, Chapter 13 Bankruptcy may enable you to pay only $10,000 for the car over 36-60 months in the Chapter 13 payment plan. The remaining balance is treated as unsecured debt. And, it will be dischargable as such at the end of the payment plan.

How can you avoid problems with cross-collateralization? There is an expression among bankruptcy attorneys that applies… “never bank where you borrow.”
If you plan on taking advantage of some of the attractive financings offers provided by credit unions, make sure that the loan is the only debt you incur with that credit union. The credit union may require you to open an additional account (i.e., a credit card) in order to qualify. That’s fine… just do not accumulate any debt on that account.

If you have questions about your loans and how they are treated in Chapter 7 Bankruptcy or in Chapter 13 Bankruptcy, please feel free to contact my office at 954-484-9987, send an e-mail to info@fleysherlaw.com, or complete the contact form below.

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