The backlash against big banks and their high fees put credit unions on the radar screens of many new customers. But if you're thinking of taking out an auto loan or applying for a credit card with your credit union, be sure to understand all the ins and outs or that relationship could quickly head south.
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Many consumers may not realize that the car they're financing through their credit union also could be used as collateral not only for their auto loan, but for another debt, such as a credit card.
So if you borrow money from your credit union for that new Toyota Camry today, then run into financial trouble two years down the road and stop paying on your credit card, the credit union can have someone come and "tow your car away," says Terry Duncan, a bankruptcy attorney with Duncan Law in Charlotte, N.C.
It's a practice called "cross-collateralization," and while banks also may have such clauses in their loan documents, the practice is much more typical with credit unions, Duncan says.
"It's a fairly common clause in credit union loan documents" as the credit unions try to "make loans less risky for them," says Mike McClain, assistant general counsel and senior compliance counsel with the Credit Union National Association (CUNA).
Unlike a bank, a credit union is a not-for-profit financial cooperative, owned by its members, so a financial loss to a credit union can impact all members, McClain says.
It might be explained, but ...
A credit union loan officer will typically explain the cross-collateralization clause to a consumer who is signing a loan document, but if that member runs into financial difficulty in three or four years, they could have forgotten about the clause, he says.
Often the issue has popped up during bankruptcy filings when a consumer has an auto loan and credit card debt with one credit union.
Keith Leggett, senior economist and vice president for the American Bankers Association, says he's rarely heard of either big banks or community banks making use of such a clause.
He says cross-collateralization is often seen in states that have been hard-hit by the economic downturn and have experienced a high number of bankruptcy filings, such as Florida and Arizona.
In 2010, bankruptcy filings climbed to almost 1.55 million in the 50 states and District of Columbia, before dropping to fewer than 1.37 million bankruptcy filings in 2011, according to federal bankruptcy data compiled by Epiq Systems.
A cross-collateralization clause "is a way of forcing people who file for bankruptcy to get them to continue to honor their debts with credit unions," Leggett says.
With cross-collateralization, card debt is secured
For those with credit card debt, it's important to "recognize this is not an unsecured loan, especially if you have a car loan" with the same financial institution, Leggett says.
Some consumers may be dealing with credit unions for the first time, as thousands fled big banks and moved their money to credit unions in 2011 in protest of big bank fees.
While final figures aren't in yet, CUNA estimates that net new-member growth topped 900,000 from September to November. CUNA takes the number of old members who closed their credit union accounts and subtracts that from the number of those who joined to determine net member growth, says Mark Wolff, the association's senior vice president of communications.
From January to November, credit unions added 1.6 million new members, compared to about 600,000 for all of 2010. At the end of 2010, credit unions had nearly 92 million members.
The cross-collateralization clause doesn't just apply to cars. It also could be used with things such as boats and recreational vehicles to secure credit cards or lines of credit that exist now, as well as in the future, McClain says.
Some CUs upfront
Some credit unions are very upfront about the practice. For example, in its loan rates posted online, GHS Federal Credit Union in Greenville, S.C., adds the note: "ALL loans are cross-collateralized by all property and shares pledged to secure any loan or advance. For example, a car pledged to secure a New Vehicle Subaccount will also secure a Personal Loan. Cross-collateralization does not apply to your home, any Keogh or IRA accounts with us or to property defined as household goods..."
A similar tactic used by financial institutions is a debt setoff, Duncan says. If, for example, you have a checking account and a credit card with a particular bank, and you fall behind on your credit card payments, your bank can take money from your checking account to pay your credit card debt.
Public Employees Credit Union in Austin, Texas, is open about the practice. A brochure for a MasterCard from the credit union makes customers pledge the money in their savings account -- up to their credit card limit -- as security for their MasterCard. The brochure states, "I understand these deposits will not be available to me for use until the MasterCard account is satisfactorily closed. I authorize PECU to apply these shares to my MasterCard account if I am in default."
Dorothy Barrick, group manager and financial counselor at the nonprofit GreenPath Debt Solutions, which does consumer credit counseling and bankruptcy counseling, says she runs into such clauses "quite regularly."
"We see it happening with banks, finance companies and credit unions," she says. In some cases, a household item such as a washing machine is used as collateral.
Finance companies provide loans to those with lower credit scores, and charge a higher interest rate, Barrick says.
In about half the cases she's dealt with, consumers weren't aware they agreed to such arrangements; in the other cases, they'd simply forgotten.
Tanisha Warner, communications manager for the nonprofit consumer credit counseling service Money Management International (and the Credit Care columnist for CreditCards.com), says financial institutions might be enforcing such clauses more aggressively as a means to recoup money they've lost in other areas, such as the loss they've taken from a federal cap on fees charged to merchants for processing debit card charges.
If you're borrowing money and feel at a loss over concepts like cross-collateralization, Warner recommends bringing a friend or family member with you to your financial institution. That person can then help ask questions and explain the loan terms.
You also might be able to get your financial institution to strike the cross-collateralization clause. But the time to ask is before you sign the paperwork, "not wait until you're in a (financial) crunch," she says.
While the experts all advise reading the fine print whenever you're signing loan documents, they acknowledge you might not read every word.
At the least, Leggett suggests asking the financial institution if a cross-collateralization clause is involved.
And you may want to think hard about borrowing money from the same place you have bank or credit card accounts. While there's nothing wrong with it if you have your financial house in order, and you may receive better interest rates on loans, it could become problematic if you run into financial difficulties, Barrick says.
"Sometimes it's not a good idea to bank where you're borrowing money," Barrick says.