This week I had a consultation with someone who is an ideal candidate for a Chapter 7 Bankruptcy, but like so many others in the same situation, they’re choosing the 3 to 5 year payment plan of a Chapter 13 because of the fine print at their credit union.
Why would someone sign up for a repayment plan that lasts 3 to 5 years instead of a Chapter 7 Bankruptcy that would be over in 4 to 6 months and involve them repaying nothing?
The reason has to do with the car this individual financed through their credit union along with a couple of credit cards and a loan from the same financial institution. Credit unions frequently use a tool called “cross-collateralization” that allows them to convert unsecured debt like credit cards and signature loans into secured debt.
Most people are unaware that these provisions are included in the paperwork they sign with their credit union to finance their vehicle, so you can imagine the shock some credit union members face when they learn that their car may be repossessed if they default on their personal loan or credit card when a credit union member finances a car with the credit union.
Similarly, when clients come to see me and all signs point toward Chapter 7 Bankruptcy being the best solution for their situation, you can imagine the frustration some of them experience when they learn that cross-collateralization may force their hand and lead them to opt into a Chapter 13 instead.
To be clear, credit union members can file for Chapter 7 Bankruptcy even if they have multiple debts with a credit union that uses cross-collateralization, they just have some difficult choices to make. If they choose a Chapter 7 Bankruptcy and they want to keep their car that’s financed through the credit union, then they’ll have to agree to also keep the credit cards and/or loans that they have with the credit union. Alternatively, they can surrender the vehicle and get rid of the credit card/loan debt as well as the debt associated with the car. For many people who would choose to keep the car, this choice can significantly reduce the benefit they would stand to gain by filing for bankruptcy in the first place, particularly if a large portion of their debt is held by the credit union.
The decision to choose a Chapter 13 Bankruptcy instead of a Chapter 7 has to do with certain benefits of a Chapter 13 that allows the portion of a secured debt that’s greater than the value of the collateral to be converted into unsecured debt. That means that the individual I consulted with this week can undo the cross-collateralization between their car and credit cards and loans, and they’ll likely be able to discharge a large portion of the debt associated with those credit cards and loans without actually repaying them due to their income. Unfortunately, the price tag on that involves them being in bankruptcy for the next half-decade because of where they bank.
The Bankruptcy Code includes many nuances just like this that trip up the unsuspecting. While it’s true that you can file for bankruptcy on your own, the risk of walking into a pitfall like cross-collateralization is real and can have very serious consequences that may greatly reduce the benefit of filing for bankruptcy in the first place. It’s important to talk with a bankruptcy lawyer about your specific situation if you’re considering filing for bankruptcy.