Bankruptcy and Credit Unions: Things to Look Out For

A credit union is like a bank. It lends money and allows you to hold checking and savings accounts. However, credit unions differ from banks in a few ways, and having a credit union account when you file for bankruptcy can cause some difficulties you might not foresee. For more information, learn about checking accounts in Chapter 7 bankruptcy.

Secured and Unsecured Debts in Bankruptcy

Not all debts are the same in bankruptcy. For instance, "secured debts" are treated differently in bankruptcy than "unsecured debts."

The most significant difference between secured and unsecured debt in bankruptcy is that you lose property if you discharge a secured debt in bankruptcy. You don't lose the property you purchased with your credit card when discharging it because it's an unsecured debt. You didn't agree to allow lender to recover the property you purchased if you failed to pay.

Typical secured debts include mortgages and car payments, while unsecured debts include credit card balances and medical bills. However, property can become secured in other ways, such as when a judgment creditor or taxing authority places a lien on the property. Learn about liens in bankruptcy.

Credit Union Cross-Collateralization Creates Secured Debt

"Cross-collateralization" turns an unsecured debt into a secured debt. Credit unions often require cross-collateralization, which is a fancy way of saying they require you to guarantee a new loan or line of credit with property you previously agreed would serve as collateral for a prior loan.

This doesn't happen without you knowing it, so it shouldn't come as a surprise. And it isn't unique to credit unions. Any lender or bank might require it. Here's what it would look like.

Suppose you took out a loan at the credit union to buy a house or car. In each case, you would have agreed to put up the house or car as collateral for the loan. If you failed to make your payments, the lender would have the right to recover the house or car in foreclosure or repossession.

If you later applied for a credit card or line of credit that typically doesn't require collateral, the credit union might require you to secure the new account with the house or car you already agreed would serve as collateral. This is how a typically unsecured debt, like credit card debt, becomes a secured debt. It's "cross-collateralized" with the collateral pledged for another loan at the institution.

Example. John takes out a secured loan from Credit Union to buy a car, putting up the car as collateral. A year later, while still paying off his car loan, John opened a credit card account with Credit Union. As a condition of the loan, Credit Union insists that John cross-collateralize the credit card with the car.

To learn more about how this works, see Credit Union Cross-Collateralization & Bankruptcy.

Losing Money in Setoffs After Filing for Bankruptcy

A "setoff" occurs when you owe money to the credit union but also have a checking or savings account with that same credit union and you file bankruptcy. If you have money in your checking or savings account with the credit union at the time that you file your bankruptcy petition, and you also owe money to the credit union for a credit card or other debt, the credit union may have the right to the money in your checking or savings account. The bankruptcy filing will cause the credit union to freeze your account and, if you do not pay back the debt, take the money from the account to the extent that it satisfies the debt.

Example. John has a credit card with Credit Union, with a balance of $5,000. John also has a checking account with Credit Union. John files for Chapter 7 bankruptcy protection. When he files his bankruptcy petition, he has $2,500 in his checking account. Credit Union freezes the account, which means John cannot withdraw any of his money. Credit Union takes the $2,500 from John's checking account as a setoff for the debt.

Loss of Membership

Credit unions are membership organizations. When a member files bankruptcy and discharges debt owed to the credit union, the credit union considers that member to have jeopardized the other members. Because of this, if you file bankruptcy and have debts with a credit union in addition to your checking or savings account, you can expect the credit union to no longer allow you to be a member unless you agree to pay back the debts.

Example. John has filed for Chapter 7 bankruptcy. He has a checking account with the Credit Union, a credit card, and a car loan through the Credit Union. His car is too expensive, and he cannot afford to repay the loan or the credit card debt, so he discharges them in his bankruptcy and gives up the car. Credit Union terminates John's membership, and he can no longer bank with the Credit Union.

Credit Unions That Work With Bankruptcies

Most banks and credit unions will not open new accounts for someone after a recent bankruptcy. Before filing for bankruptcy, you'll want to ensure you have an account at an organization that will not close your account after you file. Your local bankruptcy lawyer will likely know the prevailing policies of the institutions in your area. If not, contact the credit union or bank directly.

Learn more in Preparing for Bankruptcy: What to Do With Bank Accounts, Automatic Payments, and Utility Deposits.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true, and we want to ensure you find what you need. Below, you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.