Credit Unions and Cross-Collateralization in Bankruptcy
Posted on Mar 27, 2014 in Bankruptcy, Chapter 13, Chapter 7
Clients want to file a chapter 7 bankruptcy to clear up credit card debt and get a fresh start. Credit union customers are shocked to learn that their credit cards with a local credit union are tied together with their car loans at the same credit union.
Credit unions frequently use “cross-collateralization.” This means that your car or house not only secures your car note or house mortgage but also your credit card debts at the credit union. Normally, when you borrow a large sum of money from a bank, you give a lien on the item known as collateral. So if you borrow money to purchase a vehicle, the lender keeps the title top the car until you pay off the loan. If you default on the car loan, then the bank could enforce its lien by taking it back.
A loan with a credit union to purchase a vehicle works differently with a cross-collateralization clause. This provision has the effect of making your vehicle the collateral for all present and future loans with the credit union. So if you have a vehicle loan with your credit union and a credit card, the credit union can take back your car even if you just stop paying on the credit card.
In bankruptcy, the credit union has two secured loans; the vehicle loan and the credit card. That means, if you want to keep the vehicle in a Chapter 7 bankruptcy, you have to reaffirm the vehicle loan AND the credit card. If you don’t reaffirm the credit card, then the credit union could repossess the vehicle. You could still get rid of personal liability on both the credit card and vehicle loan, but would no longer have a car to drive.
One alternative to this dilemma is to redeem the vehicle. The Bankruptcy Code lets debtors in Chapter 7 pay the secured creditor the fair market value of the vehicle in one lump sum – the present value of the car. This is a good option when the vehicle is worth much less than the total amount of debt securing the vehicle. If the vehicle is newer this is likely not a good option. Most debtors in bankruptcy will not have enough cash to make a lump sum payment. Sometimes we can actually refinance the debt using a tool called “redemption financing”.
If the vehicle loan was signed more than 910 days before the bankruptcy was filed, you can file a Chapter 13 and propose to pay the fair market value of the vehicle over the term of the plan, either 3 or 5 years, at a little over the current prime interest rate. The remaining balance on the vehicle loan and credit card would be paid a small percent of the balance as an unsecured creditor in the plan.
As with most things in bankruptcy, it is helpful to have an attorney guide you through the process and determine the best course of action for dealing with the credit union. To avoid this situation in the future, I always advise my clients not to have more than one loan, whether secured or unsecured, with a credit union.