The sneaky cross collateralized claim

I spoke in recent posts about a debtor options when in a chapter 7.  The debtor can decide to retain a house or car that is secured by a mortgage or car note, but to do so he will have to “reaffirm” the debt that he owes to the lender.  As a refresher, when someone files for bankruptcy relief his debts are by default discharged outside of some exception.   Although the debts are all discharged, any lender that has a secured claim against the debtor’s property can retrieve the pledged collateral (there are exceptions to this rule too).  A debtor can, in most cases agree to repay the debt, and keep the collateral.  This process is memorialized by filing a “reaffirmation agreement” with the court.  This reaffirmation agreement has the effect of making the debtor again legal bound for the note.  By placing him back on the hook for the debt, the creditor’s secured claim survives the chapter 7 discharge.  If the debtor fails to pay as per the agreement, the lender has the same legal rights to retrieve the collateral by repossession or foreclosure and sue for any deficiency still owed on the note.

Clear?  Well there is a creature out there that most credit unions and some small lending institutions work into all their contracts.  This provision is called a cross collateralized claim.  A “Cross collateralized claim” has the effect of allowing the particular note to be secured by any and all assets that the debtor has pledged with the credit union or bank.  In addition, it has the power to make what appears to be a unsecured debt transform into a secured loan.

A common example I see with my clients is when they have a car loan and a credit card with their local credit union.  Once they have a feel for the way a chapter 7 works, they are confident that they will be able to discharge their credit card debt.  They believe the only decision is whether or not to reaffirm on the vehicle.  They soon find out this is not the case.   They learn that what they have actually done is actually quite different.  Of course they realize that car loan was secured by the vehicle.  However, they thought they were simply taken out an additional unsecured credit card debt.  Because of the cross collateralized claim, the impact of the credit card turns out to be something similar to additional line of credit secured by the vehicle.  The provision allows the credit union to take the vehicle as collateral, not only for the car note, but also for the credit card debt.

The impact.  Quite a different decision is in front of the debtors.  They are now faced with the dilemma of either surrendering the vehicle or reaffirming BOTH the car not and the credit card, and if you have read my posts with any frequency, you know what my advice is to them — surrender it all!!  You will survive, start over, get the fresh start that the bankruptcy code offers, and devise a plan that will allow you to go forward without owing anyone a penny on credit.