Beware of credit unions and cross-collateralization

Posted by on Dec 16, 2010 in Chapter 13, Chapter 7, General Bankruptcy | No Comments

By Jeff Curl

I have encountered a rash of clients recently that have long-term relationships with their credit unions. For those with automobile, boat home or other secured loans, there is a special danger if you also have a credit card or personal loan at the same credit union. Credit unions often have provisions in the loan documents that permit cross-collateralization, meaning that a secured loan and outstanding unsecured debt (such as a credit card) can be merged.

Assume you have a car loan from the credit union for $10,000 as well as a credit card with a balance of $5,000 from the same credit union. Chances are that both contracts for the car loan and credit card contain clauses that cross-collateralize both forms of credit. In other words, the car is not yours until you pay off both the car loan and credit card. This can cause complications in bankruptcy as well. If a debtor in bankruptcy has a car that is financed by Honda for $8,000, and $60,000 in credit card debt from various banks, and the debtor can afford and keep the car, the debtor needs only pay $8,000 (the debtor may even be able to pay less in certain circumstances, but that is a different topic). With the car financed by the credit union above, the debtor in bankruptcy may be liable for $15,000 if the debtor wishes to keep the vehicle.

Courts have referred to these cross-collateralization clauses as “dragnet clauses” because they are often broad in their nature, and buried in the credit union contracts. Most clients I meet with have never heard of these clauses and are not aware that their vehicle loans and credit card debts come tied together. Today I spoke with a credit union about a contract with a cross-collateralization clause, and she said that most of their customers have no idea these clauses exist. This comports with courts describing such clauses as “dragnet clauses.” Unsuspecting consumers should exercise caution when obtaining secured loans along with personal credit from credit unions.