The Cross-collateralization clause-found in many credit union agreements
Cross collateralization is a provision in many credit union loan agreements. It can create some complications for someone who is filing for bankruptcy. Today’s post will discuss the clause and why it matters in bankruptcy. First, let’s run though the typically scenario of the cross-collateralization clause in effect.
You decide to finance a car through your local credit union. You get the car and start making payments—everyone is happy. You know that if you do not make your car payments the credit union can come repossess the car because the car is collateral for the loan. Six months later you decide to get a credit card with the same credit union. Things seem pretty straightforward; you now have two accounts at the credit union. However, in the car loan application paperwork, buried in the fine print, is the cross-collateralization clause.
A very simplified cross-collateral clause might read: Any Collateral for this Agreement (the car loan application), shall also be Collateral for any other obligations (the credit card) owing by Borrower to Credit Union.
What does this short clause do you ask? It gives the credit union the right to use your car as collateral on the credit card debt! If you default on the credit card payments, the credit union could sell your car to pay the debt. Another issue that may occur is that even when you pay off the car loan, the credit union may not give you the car title. They will hold the title until the credit card balance is paid.
Why this matters in bankruptcy
The cross-collateral clause may turn some of your usually dischargeable unsecured debt into secured debt.
Example during a typical Chapter 7 bankruptcy
You have a car loan ($5000 balance) though Bank A and a credit card ($2000 balance) through Bank B. If you would like to keep your car, you will continue to make payments after your chapter 7 to pay down the $5000. The credit card debt is treated as unsecured debt and you would not pay back the $2000.
Example with a cross collateral clause in a Chapter 7 bankruptcy
You have a car loan ($5000 balance) and credit card ($2000 balance) through Credit Union and the loans have the cross-collateralization language from above. If you would like to keep the car, you will have to pay both the car loan and credit card debt in order to keep the car for a total of $7000.
What about in a Chapter 13 bankruptcy
The solution to a cross collateralization agreement in bankruptcy is to pay the original car loan through a chapter 13 bankruptcy plan and wipe out the credit card portion. You can do this in a chapter 13 case as long as the car is worth less then the amount owed on it under the original loan. If the car is worth more than what is owed on the car loan then you will pay the credit card debt up to the amount of value in the car after deducting for the car loan. As an example if you had a car loan of $8000 and a cross collateralized credit card of $6000 and the car value was $9000 then you would pay the $8000 car loan and $1000 of the credit card debt.
If you are unsure whether your loans are cross-collateralized, and/or you need advice regarding how your debts will be affected by bankruptcy, reach out to one of our bankruptcy attorneys for a consultation. We have offices in Wichita, Topeka, Lawrence, and Overland Park.