Don't Get Crossed Up by Cross Collateralization

Bankers will tell you that loans are based on the 3C’s – character, credit, and collateral.  People who retain me as their Austin bankruptcy attorney are nearly always people of good character who have tried to maintain good credit, but, for one reason or another, they have fallen into difficultly in their financial lives.  Their lenders at that point are looking to collateral, if any, as a source of repayment for a delinquent loan.  

Collateral is a specific pledge of an identifiable asset against a loan.   For example, your home and its associated land are the collateral for your mortgage.  Your car and boat are the collateral for those loans.  If you cannot pay the debt, your lender has the right to repossess your collateral and sell it to recover as much as possible, after which you are still responsible for any deficiency (shortfall) on that loan.  In a Chapter 7 bankruptcy, as I have discussed in a previous post, there is a special provision in the law whereby you can “redeem” an automobile by paying the lender its fair market value, no matter what the loan amount.  There is presumption that you will need a car, and the law gives you a break in that respect.

However, beware of what is called “cross-collateralization.”  This is possible but uncommon in banks. But it is more or less standard practice in credit unions.  What this means is that if, say, you have an automobile loan at your friendly neighborhood credit union and then sign up for a credit card at that same institution, the paperwork for the card probably says that your car also stands as collateral for your credit card balance.  This may or may not be explained by your loan officer, and it is probably buried in the fine print somewhere.  So, if you arrive at the need to file a Chapter 7, you may find that instead of a dischargeable credit card debt you have a secured credit card.  To keep your car, you’ll need to “reaffirm” that card balance along with your car loan balance and budget to pay off both in full.  There may be absolutely no ill intent here, and several years may have passed since you signed the papers you never read, but you’re trapped.

It is unusual for a credit union to loan against a home, but the good news is that if a home is part of a cross-collateral agreement, it is not subject to collection efforts in a Chapter 7.  The Homestead Exemption still applies. 

So, if you have loans with a credit union, as your bankruptcy lawyer I like to discuss all your bank and credit union relationships to look for cross-collateral agreements.  I can’t undo them, but knowing they exist will affect my analysis of your situation and my strategy as to how best to handle your case.  Don’t think you are alone with this; it’s a very common problem.   And credit unions serve a valuable role in our financial system.  It’s just one of many instances in which nuances of standard lending practices can have a significant effect on the outcome of a bankruptcy proceeding.