The Risks of Auto Loan Cross-Collateralization
What You Need To Know About Credit Union Car Loans
The old adage, "Don't put all your eggs in one basket," is sound advice when you're investing, but it can hold true when you're borrowing as well.
With many financial institutions pushing to develop strong relationships with their clients, it's natural to check with your bank or credit union when shopping for an auto loan.
But that relationship could end in a nasty row if you run into financial trouble and don't pay all your bills on time.
In many cases, if you finance a vehicle through your credit union, that vehicle will serve not only as collateral for your auto loan, but also is used to secure other kinds of debt you have with your credit union, such as a credit card or personal loan.
The practice of using an auto loan to secure other types of debts is called cross-collateralization, and that means if you have a credit card with your credit union and fail to the pay the bill, your car could be repossessed.
"Credit unions are generous on their loan terms and harsh on their default terms," says attorney David Leibowitz, founder of Lakelaw in Chicago. He frequently handles bankruptcy cases.
Because credit unions are member-owned, not-for-profit financial cooperatives, a financial loss can have an impact on everyone who belongs to that credit union, says Mike McLain, assistant general counsel and senior compliance counsel with the Credit Union National Association (CUNA).
The cross-collateralization clause is designed to reduce the risks associated with lending. "It's a fairly common clause in credit union loan documents," McLain says.
That means it's imperative that you read all the fine print whenever you plan to take out a loan, says Todd Mark, vice president of education for the Consumer Credit Counseling Services of Greater Dallas. Mark suggests asking if the cross-collateralization clause can be deleted from the contract.
He also recommends shopping around for both your auto loan and a new credit card. You might be able to find an auto loan at an acceptable rate at a bank or through your dealership's finance company. And there are typically an abundance of choices if you're looking for a credit card.
"This could be one of the few cases where it could be detrimental to have multiple accounts with one financial institution," Mark says. "Given the last five years in the economy, you never know when something unexpected will happen."
Credit Union Popularity
At the end of 2012, credit unions had about 95 million members, up from a little more than 80 million members a decade before, according to CUNA's annual report. Credit unions have particularly benefited from consumers' dissatisfaction with big banks in recent years.
As the number of credit union members has climbed, so has its share of the market for auto loans. According to a report by the Filene Research Institute, a think tank backed by the credit union industry, the share of auto loans made by credit unions jumped from 13 percent in 1986 to 20 percent in 2011.
Over that same time, auto loans made by banks dropped from 47 percent to 32 percent, while loans made by auto dealers' in-house finance companies climbed from 40 percent to 48 percent.
The shift has been fueled in part by finance companies charging lower rates for auto loans than banks have, the Filene report says.
And credit unions have fared well because their auto loan interest rates have, on average, been 1.05 percent lower than those of banks. For credit unions, "the main overarching benefit tends to be [loan] prices," says George Hofheimer, Filene's chief research and innovation officer.
As of March 2013, the average rate on a 60-month loan from a credit union for a new car was 2.9 percent APR, compared to 4.1 percent APR at a bank. The average rate on a 24-month loan for a used car was 2.98 percent APR at a credit union, compared to 4.47 percent APR at a bank, according to the National Credit Union Administration.
That difference is important for auto-loan shoppers. It's extremely common for consumers to focus on the monthly payment and annual percentage rate, while giving short shrift to the fine print.
While a credit union may tell its members about its policy of cross-collateralization of debt, "rarely do people give a lot of thought to truth-in-lending disclosures in financial transactions," Leibowitz says.
Checking the Fine Print
If you look closely, you might find wording such as: "All loans are secured by any property specifically pledged and shares on deposit with the credit union. In addition, 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 car loan will also secure a personal loan."
And if your credit union does disclose its practice when you're signing on the dotted line, it's something that could easily slip your mind if you run into financial difficulties several years down the line.
Banks also can have cross-collateralization clauses in their auto loan disclosures, but 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.
The issue of tying together auto loans and other debt is most likely to crop up in states that were walloped during the recession, such as Florida and Arizona, Leggett says, and the upsurge in bankruptcy filings brought the practice to light.
2012 alone saw more than 1.2 million bankruptcy filings in the 50 states and District of Columbia. Although that's down substantially from the almost 1.55 million bankruptcy filings in 2010, the economic downturn has left millions of consumers in financial distress.
As the economic picture has brightened, the number of new car sales has been on the rise. The number of new vehicles sold had plunged from more than 17 million in 2005 to 10.6 million just four years later. By the end of 2012, auto sales had rebounded to nearly 15 million, according to the Filene Research Institute report. Sales projections indicate that nearly 16 million new cars will be sold in the U.S. in 2013.
Meanwhile, at the end of 2012, credit unions had more than $180 billion in outstanding auto loans. Banks had more than $325 million in outstanding vehicle loans, according to a report by the financial information services firm Experian.
Don't Write Off Credit Unions
Because credit unions typically offer lower interest rates, Leibowitz sees no reason for consumers to avoid them when looking for an auto loan. "Everything is fine as long as you're not in default."
If you fall behind on your car loan, the credit union might also seize your checking or savings account to help pay your loan. If clients fear that might happen, Leibowitz says he advises them to move their checking and savings accounts to another financial institution.
He has found that some credit unions are very willing to work with borrowers if they're running into financial trouble and can't make their car payments on time.
Filene's Hofheimer agrees. "Generally speaking, credit unions work with customers a lot longer before something is repossessed." Rather than automatically seizing the car, a credit union will try to find a way to deal with the problem.
Mark is more wary of the potential impact of the cross-collateralization clause. "The credit union is looking to reduce its risk. On the consumer side, I would want to reduce my risk," Mark says.