Imagine a scenario where you are willing to sell your car, which you now own for free, to have your lender tell you that you cannot sell it until you pay off another unsecured loan you have with the same lender. Essentially, the lender tells you that you haven’t finished paying for your car and the title still belongs to the lender.
This is the result of an obscure clause called a cross guarantee, which is used by lenders in certain lending situations. You might not have known it unless you carefully dissected your contract only to find it buried deep in the fine print.
Even if it was explained to you by your lender, there’s a good chance that it was forgotten three or four years ago in your loan, which is why most borrowers are caught off guard.
What is a cross collateral loan?
Cross-collateralization is a method used by lenders to use collateral for a loan, such as a car, to secure another loan that you have with the lender. While this may seem like a reasonable precaution taken by the lender, borrowers often do not realize how much control the lender has over their finances when exercising it.
Credit unions, which generally offer better loan terms than other lenders, frequently use cross-secured loans
This can prevent you from selling your car if the lender wants you to keep it as collateral. Worse, if you fall behind on another unsecured loan, like a credit card, the lender can repossess your car. If you file for Chapter 7 bankruptcy, you may be required to transfer your car to the lender until your outstanding debts have been paid.
Key points to remember
- Cross-guarantee is a method used by lenders such as credit unions to use the collateral for one loan product to secure another.
- Lenders who offer auto loans can use cross-secured loans in their lending practices.
- Mortgage lenders can use cross-collateralized loans when providing construction loans to buyers who own more than one property.
Practices of credit unions
While cross-guarantee loans are commonly used in auto loans, these loans are much more prevalent with credit unions. Credit unions operate differently from banks in that they are owned by their members, so the clause is additional protection against loan losses that would be shared by members.
The attraction of credit unions has always been their willingness to extend better loan terms, especially when you already have a relationship with them. If you finance a car through a credit union or have a savings account with it, you are likely to receive low rate unsecured loan offers. This is because credit unions can guarantee these loans with the guarantee of your car loan or your savings.
Credit unions are an attractive banking and lending alternative for a number of reasons, including lower banking and borrowing costs. The practice of cross collateralization could be a downside if you are not aware of the potential impacts on your finances.
If you are considering a loan from a credit union, it is important to take some precautions.
- First, don’t take more than one loan at a time from a credit union.
- Second, don’t set up a credit card or line of credit account with a car loan.
- Third, don’t bank where you borrow; keep your checking account at another institution. Finally, always read the fine print on any loan document.
Cross-collateralized loans in mortgages
Cross-collateral loans are also used in mortgages, primarily with construction loans when a borrower owns multiple properties.
For example, if a builder who owns more than two properties is seeking financing for a new project, the lender may want to secure the new loan by placing a lien on one or more of the other properties. The lender becomes the primary lien holder on all properties, making them difficult to sell.
The bottom line
As with any form of loan, whether it is credit cards, installment loans, lines of credit or mortgages, it is always the borrower’s responsibility to understand all aspects of credit terms, which are written primarily to maximize and protect the lender’s income. against losses.