Cross-collateralization is the act of using an asset currently used as collateral for an initial loan as collateral for a second loan. If the debtor was unable to make either loan’s scheduled repayments on time, the affected lenders can eventually force the liquidation of the asset and use the proceeds for repayment.
BREAKING DOWN Cross Collateralization
Taking out a second mortgage on a property is considered to be a form of cross-collateralization. In such a case, the property is used as collateral for the original mortgage. The second mortgage then taps into the equity that the property’s owner accrued for collateral.
There is a reverse circumstance wherein cross collateralization comes into play. Multiple real estate properties could be listed as collateral for one loan, which is typically the case for a blanket mortgage.
Ways Cross Collateralization Is Used to Secure Multiple Consumer Finance Accounts
Cross-collateralization can be applied to other forms of financing. Consumers who obtain financing from a credit union to purchase a vehicle might sign a loan agreement that uses the vehicle as collateral. What the consumer might not be aware of is that the loan agreement may stipulate that the vehicle will also be used as collateral to secure any other loans or credit they take out with that credit union. The lien that is placed on the car from the initial loan would then apply to all other financing accounts the consumer opens with that institution.
This could lead to circumstances where a consumer who is late on a credit card payment with a credit union has their car repossessed even though they are current on their car loan payments. It is possible that the cross-collateralization clause is overlooked by the consumer leaving them unaware of the multiple ways they might lose their property.
Banks might also cross collateralize property if a customer takes out a car loan and then follows up with other financing accounts at the bank. There is a reluctance among banks to cross-collateralize a piece of property that is already used to secure financing with other banks.
Consumers who file for bankruptcy while some of their property is tied up in cross collateralization might attempt to enter reaffirmation agreements for all the financing secured by that collateral. They would then continue to make payments on those loans in order to retain possession of the property.
Another option is to allow the collateral to be repossessed. The debts that were secured by that collateral would be discharged at the end of the bankruptcy but the property would no longer be in their possession.