Cross collateralization can trip up borrowers

Ervin and Patricia Hartley assumed they would be driving their 2005 Dodge Dakota for quite a while longer.

The Litchfield Park residents, both in their 60s, say they had less than $1,000 left to pay on the truck's loan. Despite facing financial difficulties triggered by Ervin's medical problems, they expected to keep the vehicle.

But when the couple filed for Chapter 7 bankruptcy with the aim of discharging credit-card and other debts, the Hartleys wound up temporarily losing the vehicle.

The reason: The auto loan they obtained from Arizona Federal contained a clause that allowed the credit union to retain title to the truck until the Hartleys paid off everything they owed, including balances on other loans.

The clause in question involved "cross collateralization." This allows financial firms to use assets securing one loan as collateral for others, including loans taken out later.

Cross collateralization is common, even if many people don't realize it.

"I can't remember how many cars we have bought through Arizona Federal over the years - at least five or six - and I had never heard of it," Patricia Hartley said.

With cross collateralization, a lender also can block you from selling a paid-off auto if you have other debts outstanding with the institution.

Cross collateralization tends to be used more by credit unions than banks, said Phoenix attorney Jon Frutkin, who is representing the Hartleys.

"Everyone thinks about the big bad banks," Frutkin said. "But this is a credit-union thing."

Unlike banks, credit unions are owned by their members, not investors, and they've built a reputation for being customer-friendly by paying slightly higher deposit rates and charging less on loans.

But cross collateralization, Frutkin said, is "not in the best interest of members."

Phoenix bankruptcy attorney Diane Drain said she, too, has noticed more enforcement of cross collateralization lately by credit unions, not banks.

"Credit unions will try to cross-collateralize everything," Drain said.

If your finances deteriorate to the point where you fall behind on other debts, cross collateralization could make your vehicle a repossession target. Even bankruptcy won't necessarily help, as the Hartleys learned in filing for Chapter 7 protection.

If you signed papers with a cross-collateralization clause, you might not retain the vehicle unless you pay all your debts, including IOUs that get discharged in bankruptcy.

Cross collateralization is legal in Arizona but lenders must provide clear disclosure, Frutkin said.

Nor does it apply solely to auto loans.

"You can have them for boat, home-equity, trailer, RV or other loans - pretty much anything," he said.

Residential mortgages usually aren't cross-collateralized but could be, especially if tied to business loans, Frutkin said.

The Hartleys say they weren't aware of cross collateralization.

After the truck was initially repossessed April 14, they say they orally negotiated a deal with Arizona Federal to get it back, prior to filing for bankruptcy protection.

They paid $2,567 on April 22, with the money applied to the truck loan, another auto loan and a credit-card balance, with $300 placed into an Arizona Federal savings account.

They did this believing they were back on track for keeping the truck, which was returned, and affirmed their intention to pay off that debt when they filed for bankruptcy on April 26.

"I honestly thought we were in good standing," said Patricia Hartley, adding that she wouldn't have made the $2,567 payment if she expected to quickly lose the truck again.

But after the filing, Arizona Federal declared the Hartleys in default and repossessed the truck again.

What's disturbing, said Frutkin, is that lenders aren't supposed to "trick people by getting them to write a check when they know they're going to repossess the car."

Pat Bodnar, executive vice president of the Mountain West Credit Union Association, an industry group in Phoenix, said credit unions tend to use cross collateralization more than banks because they are true cooperatives.

"When there's a loss, it's a loss to all the members," she said. "When you hurt a credit union, you hurt all the members."

The provisions also give members added incentive to pay their debts, Bodnar said, adding that credit unions try to work with members, not trick them.

A legal response from Engelman Berger PC, the Phoenix law firm representing Arizona Federal, countered that there's no evidence the Hartleys had been tricked into believing they were in good standing on the truck loan.

It also asserted that the credit union didn't rely solely on cross collateralization, noting the Hartleys failed to make biweekly payments on the truck starting in mid-May.

The Engelman Berger response also indicated Arizona Federal's loan documents warn borrowers, in bold lettering, that "property given as security for this loan or for any other loan will secure all amounts you owe the credit union now and in the future."

The Hartleys have since gotten the truck back again and face court-ordered mediation to determine how much more they must pay to keep it.

Meanwhile, the case provides a wake-up call for others. Be sure to read the fine print, including loan documents you co-signed with someone else.

And if you have more than one credit card or other loan with the same financial entity, you could be bound by cross collateralization, especially if your lender is a credit union.

by Russ Wiles, columnist The Arizona Republic Sept. 25, 2011 12:00 AM




Cross collateralization can trip up borrowers