Cross collateralization can leave people with hard choices in bankruptcy

Credit unions are a popular alternative to traditional banks for many people. Members say they enjoy an atmosphere that is more focused on the customer and the better rates they can sometimes get on loans and savings accounts. However, credit unions often use cross collateralization with their loans, which can be detrimental to the borrower, especially when the borrower is seeking discharge of his or her debts in Chapter 7 bankruptcy.

Chapter 7 bankruptcy

Chapter 7 bankruptcy is a valuable tool for people overwhelmed by debt because it gives them the opportunity to obtain a fresh financial start. Upon filing for bankruptcy, all debt-collection actions must stop. An "automatic stay" is imposed that puts an end to harassing phone calls from debt collectors and halts repossession or wage garnishment proceedings. In addition, all unsecured debt such as medical debt and credit card debt usually can be discharged in Chapter 7 bankruptcy, meaning the borrower is no longer legally responsible to pay the debt.

When a borrower has a loanliner agreement with a credit union that has cross collateralized debt, however, the borrower may be forced to make a tough decision regarding debt discharge.

Cross collateralization

Credit unions often use cross collateralization to secure their loans. This means that something of value that is already being used as collateral for one loan is also used as collateral for a second loan.

For example, a credit union may give a borrower a car loan and use the car as collateral for the loan. If the borrower stops making payments on the car loan, the credit union can repossess the car and sell it, using the money for repayment. With cross collateralization, when the borrower gets a second line of credit with the credit union, such as opening a credit card, the credit union will use the car as collateral for the credit card debt as well. Then, the credit union can repossess the car if the borrower does not pay his or her credit card debt, even if the car loan is fully paid off.

This cross collateralization can be particularly problematic in Chapter 7 bankruptcy. The bankruptcy filer likely wishes to discharge his or her credit card debt in bankruptcy, but if that debt is secured by his or her car through cross collateralization, the filer must choose between reaffirming the debt (continuing to be obligated to pay it) and keeping the car or discharging the credit card debt but losing the car as collateral. This can be a difficult decision, but if the value of the car is much less than the amount of outstanding credit card debt, the filer often elects to give up the car.

Filing for bankruptcy is a way to obtain relief from unmanageable debt, but the procedures can be complex. If you are struggling to make ends meet, contact a knowledgeable bankruptcy attorney to learn about the debt-relief options that may be available to help you.