Cross Collateralization: The Credit Union’s Dirty Little Secret

Imagine this scenario: You are ready to sell your car, that you now own free and clear, only to be told by your lender that you can’t until you pay off another unsecured loan you have with the same lender. In essence, you are being told that you are not through paying on your car, and the title still belongs to the lender. How is that possible? It’s the result of an obscure clause called cross collateralization. You wouldn’t have known about it unless you carefully dissected your contract, where you would have found it buried deep in the fine print. Even if it was explained to you by your lender, chances are it would be long forgotten by the time you were three or four years into your loan, which is why most borrowers are caught off guard.

Photo by tomas belardi via Flickr

What Exactly is Cross Collateralization?

Essentially, cross collateralization is a method used by lenders to use the collateral of one loan, such as a car, to secure another loan you have with the lender. While that may, on the surface, appear to be a reasonable precaution taken by the lender, borrowers often don’t realize the amount of control the lender has over their finances when it is exercised. It can keep you from being able to sell your car; worse, if you fall behind on another unsecured loan, it can take your car; and, if you need to file for Chapter 7 bankruptcy, it could require you to relinquish your car to them until outstanding debts have been satisfied.

While cross collateralization is an established practice in auto lending,, you are more likely to come across it with credit unions. Credit unions operate differently than banks in that they are owned by their members. So, the clause is an added protection against loan losses that would be shared by the members. The appeal of credit unions has always been their willingness to extend more favorable loan terms, especially when you have an existing relationship with them. If you finance a car through a credit union, or have a savings account with it, you will likely receive offers for low rate unsecured loans, such as a low interest rate credit card. That’s because they can secure those loans with the collateral from your auto loan or savings.

Much has been written about the virtues of credit unions as banking alternatives for people who have grown weary of big, impersonal banks and their “nickel and dime” fee structure.  In a number of articles we’ve expounded on the advantages and disadvantages of banking with credit unions, with the tendency to favor them for their superior customer service and more favorable loan and savings rates. But, their proclivity for including this particular clause in their contracts should give you pause before establishing any kind of relationship with them.

It always comes down to “Borrower Beware”

Credit unions are an attractive banking and lending alternative for a number of reasons, and you shouldn’t be deterred by the potential problems that could arise out of a cross collateralization clause in your auto loan if you take a few precautions.

• Don’t take out more than one loan from a credit union.
• Don’t establish a credit card account or line of credit where you have an auto loan.
• Don’t bank where you borrow. In other words, keep your checking account at a different institution.
• And always read the fine print. Better yet, have an attorney read it for you.

As with any form of lending, be it credit cards, installment loans, lines of credit, or mortgages, the burden is always on the borrower to understand every aspect of the credit terms which are written primarily to maximize the lenders revenues and protect them against losses.

Monica Clark

Monica Clark is the Managing Editor at Directbanc. Directbanc strive to help consumers by providing unbiased information and educational articles about financial products in order to improve their finances.