Cross-Collateralization Agreements in Bankrupty

What is a cross-collateralization agreement?

A cross-collateralization agreement is a type of consumer contract that provides for property to be used as collateral for two or more loans. For example, a cross-collateralization agreement could provide that your car serves as collateral for a credit card and personal loan, in addition to your car loan. This type of agreement is commonly used by credit unions and community banks.

What happens if I default on a cross-collateralized loan?

If you have cross-collateralized loans, then your collateral is typically security for every loan with that credit union or bank. Turning back to our car loan example, this means that even if you are current on your car loan, your car could be repossessed if you default on any of the other loans you have with that lender.

How does a cross-collateralization agreement affect your bankruptcy?

If you want to eliminate debt through a Chapter 7 Bankruptcy, cross-collateralized loans could throw a monkey wrench in your plans. Under the Bankruptcy Code, all of the loans subject to the agreement would be considered secured claims. This means that in order to to keep your property, you would have to either redeem or reaffirm all of the cross-collateralized debt.

To demonstrate how this affects a Chapter 7, here’s a hypothetical. Let’s assume that you own a car worth $5,000.00. You have a $6,000.00 balance on your car loan, a $15,000.00 personal loan, and you signed a cross-collateralization agreement with your lender. If you want to file a Chapter 7 Bankruptcy and keep your vehicle, you would have to either redeem the property by making a lump-sum payment of the fair market value of the vehicle ($5,000.00) or reaffirm $21,000.00 in debt. Neither of these are great options.

So what is a better solution? Depending on your circumstances, one option may be to file a Chapter 13 and reorganize your debt. A Chapter 13 Bankruptcy requires that a debtor repay at least a portion of their debt over a three to five year period. A major advantage, however, is that debtor can “cramdown” certain secured debts. This would allow the debtor in our hypothetical to pay off the car at its fair market value ($5,000.00) and treat the remaining $21,000.00 as unsecured debt which could be discharged by the bankruptcy.

To find out if you qualify to file bankruptcy, and which solution is right for your financial circumstances, you should consult with an attorney. To schedule a free bankruptcy consultation with The Mays Law Firm PC, call (215) 792-4321.