What is “Cross-Collateralization,” and How Might it Affect My Bankruptcy?

August 13, 2013

Cross-collateralization is a process where a bank or credit union will contractually turn an unsecured debt (such as a credit card) into secured debt (like a mortgage) by tying it to another loan. The easiest way to explain this is by looking at the most common example, a credit card and a subsequent car loan from a credit union:

Joe has a credit card with Federal Credit Union. Joe carries a balance of around $5,000 on his Federal Credit Union credit card. At some point, Joe decides that he wants to purchase a vehicle. Federal Credit Union offers him a better interest rate than other lenders so he decides to finance his vehicle with Federal Credit Union. Joe decides to buy a $20,000.00 car. He pays $2,000 down, so he only needs to finance $18,000.00 of it. Federal Credit Union agrees to lend Joe this money, but only if he will agree to “cross-collateralize” his credit card debt and attach a security interest onto his new vehicle. What this essentially means is that Joe will now owe Federal Credit Union $23,000.00 ($18,000.00 on the car loan plus the $5,000.00 credit card debt) to pay off his car in full instead of just the $18,000.00.

Cross-collateralization clauses can often come as surprises to consumers who expect the title to their car after they have paid off their car note. It can also complicate decisions when looking into filing a bankruptcy. In a Chapter 7 most “unsecured” debts can be discharged; meaning that the consumer won’t have to pay back those debts. The most common types of unsecured debts are medical bills, payday loans, and credit card debts. However, in order to keep secured debts in a Chapter 7, you have to continue to pay on these debts if you want to keep the collateral (like a mortgage or car note).

Using the example above, what would happen to Joe’s car debt if he decided to file for bankruptcy? For purposes of this example, let’s say that Joe’s car was now worth $15,000.00, he owed $10,000.00 on the car, and owed Federal Credit Union $8,000.00 in credit card debt. Typically, unsecured debts like credit cards are discharged in a Chapter 7; however, because Federal Credit Union put a cross-collateralization clause in his car loan contract, the $8,000.00 credit card debt Joe owes is no longer “unsecured”. Instead the loan is “secured” because it attaches to Joe’s vehicle worth $15,000.00. What this means for Joe is that instead of discharging the debt, Joe is now going to have to pay Federal Credit Union $18,000.00 to keep his vehicle that is only worth $15,000.00; thus taking away any equity that Joe had in the vehicle.

If you are interested in filing bankruptcy and have a cross-collateralized loan (or if you’re not sure whether or not you have one), it would be well worth your time to consult with an experienced bankruptcy attorney who can walk you through your options. For a free consultation, call the experienced attorneys at Fears Nachawati Law Firm today.

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