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Cross Collateralized Loans And Bankruptcy

By Kevin Gipson, New Orleans Bankruptcy Attorney

What is cross collateralization and how can it affect your Bankruptcy?

When a loan is cross-collateralized it means that you have made an unsecured creditor into a secured creditor.

How does this happen?

When you purchase a car, it is common for the documents you sign to give the lender a security interest in the car.

 The car becomes collateral for the debt.   This type of debt is often referred to as a “collateral mortgage”.

The agreement allows the lender to hold the title to the vehicle until you pay it off. If you don?t pay it off, then the security agreement permits the lender to repossess your vehicle.

Such a provision is understood by pretty much everyone that has ever purchased a vehicle.

However, credit unions, and to a lesser degree, banks will frequently put a provision in the security agreement that allows the lender to secure any other debt that you may have with that financial institution using the vehicle as well. Very few people are aware that such a provision exists when they signed for their vehicle.

If you then go back to the credit union or bank that gave you the vehicle loan and get a credit card, a line of credit, or some other type of loan that would normally be unsecured, the vehicle will act as collateral for the credit card or line of credit.

This occurs because you have already signed an agreement when you took out the car loan agreeing that it secures any other loans that you get with that lender:  You have now created a secured debt on the credit card or other unsecured debt.

How can this type of agreement affect your bankruptcy?

When you file a Chapter 7 you can discharge you unsecured debt.

With your secured car loan you generally have two options: you can surrender the vehicle or you can reaffirm the debt and keep the vehicle.

However, when you file a Chapter 7 and you have a vehicle loan and other loans at the same credit union or bank that are cross collateralized, then it is likely that you will have to pay all of them if you want to keep your vehicle.

One solution to this problem may be to file a Chapter 13 since more options are available regarding vehicle loans in a 13, but like many things in bankruptcy, there are pros and cons that must be weighed.

Consult an experienced bankruptcy attorney to review your options.

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Full post as published by Credit Law Network on March 02, 2011 (boomark / email).