Credit Union Cross-Collateralization and Bankruptcy

Watch out for cross-collateralization with credit union accounts in bankruptcy -- debts you think are unsecured might be secured.

By , J.D. · Wayne State University Law School

Credit unions offer many benefits that regular banks do not; however, they also engage in certain practices that may hinder you if you decide to file bankruptcy. One of these practices is cross-collateralization.

What is Cross-Collateralization?

When you take out a loan to buy a large item, such as a car, you give the lender a security interest in the item. This means that if you don't make your loan payments, the lender can take the item and sell it to satisfy the debt. In this situation, the property is called "collateral".

When you borrow money from a credit union to buy something, the loan agreement may contain a clause that says that not only is the property collateral for the loan you're obtaining to buy it, but it will also be collateral for any other loans you take out through the credit union. That includes credit cards and personal loans.

Example. Anne buys a car by taking out a loan from her credit union. The loan agreement for her car loan contains a cross-collateralization clause. Anne later opens a credit card account with her credit union and uses it to pay for some vacations. After three years, Anne pays off her car loan, but she still has a balance due on her credit card. Anne loses her job and stops making her credit card payments. The credit union can repossess her car and sell it to pay the credit card debt.

How Does Cross-Collateralization Affect a Bankruptcy?

When you file bankruptcy and you have a secured loan, you must repay the loan if you want to keep the property that secures the loan. So, if you owe money on your car when you file bankruptcy, you have to pay back the loan if you want to keep your car.

Unsecured loans, such as personal loans and credit card debt, are generally dischargeable. In a Chapter 7 case, you can wipe out many unsecured debts completely, and in a Chapter 13 case, you can pay pennies on the dollar and get rid of the rest. However, cross-collateralization takes debts that would normally be unsecured and makes them secured. If you want to keep the collateral, you have to agree to pay back the loan; otherwise, you can discharge the loan in bankruptcy, but you must return the collateral.

Example of a typical bankruptcy situation. Tom has a car loan through Bank A. He also has a credit card through Bank B. Tom files for Chapter 7 bankruptcy. He wants to keep his car, so he agrees to repay his loan to Bank A. He no longer wants his credit card, and since it is an unsecured debt, it is discharged in his bankruptcy and he does not need to pay it back.

Example of a cross-collateralization situation. Tom has a car loan and a credit card through Credit Union. His car loan contained a cross-collateralization clause, so his car secures not only the car loan but also the credit card debt. Tom files for Chapter 7 bankruptcy. If he wants to keep his car, he must agree to repay both the car loan and the credit card in full.

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