Banks and credit unions are very different types of financial institutions. They both have positives and negatives from the consumer’s point of view.

One of the BIGGEST negatives associated with credit unions is the “cross collateral clause” which is usually buried deep within the fine print of credit union documents.

A cross collateral clause is a provision which states that the item being financed or the item being pledged as security (usually your car) also secures any other debts you currently have or may have in the future with the credit union.

Here’s how this usually plays out. You take out a car loan from your credit union. Buried in the fine print is the unnoticed cross-collateral clause. Later, you get a credit card from the credit union and over time build up a $10,000.00 balance on the credit card. Sometime later, you file Chapter 7 bankruptcy, at a time when the balance owed on your car loan is $5,000. Your expectation is that you will discharge (wipe-out) the $10,000 credit card debt in bankruptcy but keep your car and owe the credit union only the $5,000 balance that remains on the car loan.

Sorry! This is usually when the credit union first brings the cross-collateral clause to your attention by threatening to repossess your car if don’t pay both the $5,000 car loan and the $10,000 credit card debt.

While your bankruptcy will discharge the $10,000 credit card debt, it doesn’t wipe out the lien the credit union has on your car. And because of the cross-collateral clause, not only did you pledge your car as collateral for the car loan, you also pledged your car as collateral for your credit card debt as well as any other debt you owe the credit union.

The unfortunate result is that you most likely are going to have to choose to either pay both the $5,000 car loan and the $10,000 credit card debt if you want to keep your car, or you can surrender the car in the Chapter 7 bankruptcy and discharge both debts.

Another option is to file a Motion to Redeem the car which would require you to make a one-time lump-sum payment for the car’s fair market value. However, when dealing with a motor vehicle, the lump-sum amount necessary to redeem is usually more than my bankruptcy clients would be able to come up with so it’s generally not a realistic option.

Or a person could file a Chapter 13 bankruptcy instead of a Chapter 7 bankruptcy and take advantage of the “cram-down” provision which requires you to pay the credit union only the fair market value of the car as long as you signed the car loan documents over 910 days before you file your Chapter 13 case. If so, any amount that you owe on the car loan over and above the car’s fair market value becomes a general unsecured debt and can be discharged just like the credit card.

However, Chapter 13 bankruptcies are generally not the type of bankruptcy the average consumer would choose to file unless the reason they are filing bankruptcy is to stop a foreclosure or deal with back income taxes, back child support or large student loans. A Chapter 13 bankruptcy is much more expensive than a Chapter 7 bankruptcy. Where a Chapter 7 bankruptcy normally lasts about 4 months from filing date to case closure, a Chapter 13 bankruptcy will last from 36 to 60 months during which you will have a bankruptcy judge, bankruptcy trustee and bankruptcy attorney involved in your personal financial affairs and you will not have ultimate freedom in your financial decision making.

So, how can you avoid finding yourself in this scenario? Here are two recommendations that will help:

1) Don’t have more than one secured loan with the same credit union, and

2) Don’t have a secured loan and a credit card, line of credit or other unsecured debt at the same credit union.