Credit unions work out great for many consumers. They offer many benefits traditional banks cannot compete with. But there is a dirty little secret credit unions spring on unsuspecting members with vehicle loans, credit cards and personal loans.
Cross-collateralization is a common policy at credit unions. Members experiencing financial difficulty are often shocked when they discover unsecured credit cards and personal loans are actually secured through the policy of cross-collateralization.
What is Cross-Collateralization?
Most consumers know when you take out a vehicle loan, you give the lender a security interest in the vehicle. This means if you miss loan payments, the lender can repossess the car and sell it to satisfy the debt. The car is “collateral” for the loan.
What most consumers don’t know is when money is borrowed from a credit union, the loan agreement may contain a clause that says not only is the property collateral for the loan you’re obtaining but it is also collateral for any other loans you take out with the credit union. The other loans could be credit cards or personal loans.
What Cross-Collateralization Means for Members
Credit cards and personal loans are typically unsecured loans. This means there is no security or collateral involved. If you fail to pay the credit union has no collateral to satisfy the debt.
But with the cross-collateralization clause members with a vehicle loan, even if that vehicle loan is being paid on-time, the vehicle can be repossessed if other loans at the credit union are late. That vehicle will serve not only as collateral for your auto loan, but also is used to secure other kinds of debt you have with your credit union, such as a credit card or personal loan.
Example. Tasha takes out a car loan with her credit union. Unbeknownst to her, the vehicle loan agreement contains a cross-collateralization clause. Tasha later opens a credit card account with her credit union and gets a signature loan to go on a cruise. Four years have passed and Tasha pays off her car loan and is anxiously awaiting the car title. However, due to a financial set-back she is behind on her credit card payments. The credit union can repossess her car and sell it to pay the credit card debt.
Cross-Collateralization and Bankruptcy
Unsecured loans, such as personal loans and credit card debt, are generally dischargeable in a Chapter 7 bankruptcy filing. You can wipe out many unsecured debts under a Chapter 7 bankruptcy. Many consumers filing bankruptcy choose to keep their car and make some type of payment arrangements. But with cross-collateralization unsecured debts at the credit union become secured. If you want to keep the collateral, you have to agree to pay back the unsecured debt. You can discharge the loan in bankruptcy, but you must return the collateral. This only happens when all of your debt is at the same credit union.
How to Avoid Cross-Collateralization
It’s nice to have a good banking relationship with your financial institution. Having all your loans and other banking products in one place makes sense. But watch-out for the old adage, “Don’t put all your eggs in one basket.”
Most larger and even community banks have a cross-collateralization clause in loan agreements. The difference is they choose not to use it. But at credit unions it is pretty much standard operating procedure to enforce the cross-collateralization clause.
Credit unions are generous on their loan terms often extending credit to members with less than perfect credit histories while still offering decent rates and terms. Credit unions will extend loans when a traditional bank will not.
But when it comes to financial loss, a credit union can be harsh because they are member-owned, not-for-profit financial cooperatives. A financial loss can have an impact on all credit union members.
The cross-collateralization clause is designed to reduce the risks associated with lending. It’s a clause in most credit union loan agreements. Don’t be shocked when the credit union pulls enforces it. Read all the fine print whenever you plan to take out a vehicle loan at a credit union.
Credit Union Members Should Diversify
If your vehicle loan is with the credit union make that your only loan at that institution to avoid being trapped by cross-collateralization. Find your credit cards at a bank or credit card issuer other than the credit union. Of course you don’t plan on defaulting on any type of loan but just in case there is a financial hardship you will not experience the shock of having your vehicle repossessed to pay your credit card debt.