Cross collateralization occurs when security (collateral) pledged on one loan is, by terms of an agreement between lender and borrower, also collateral for another loan.
The effect of cross collaterization is that the asset that constitutes the security remains encumbered until all loans are paid in full.
This is a trap for the consumer that may unwittingly arise where the individual has several loans from a credit union or bank. The fine print may provide that what is discussed as an unsecured line of credit is really also secured by the vehicle being purchased on a separate secured car loan, for instance.
The Chapter 7 debtor may find, after his case is concluded, that the lender refuses to give him the pink slip upon pay off of the car loan, claiming that it is also security for other debts to the lender.
Remember that the bankruptcy discharge eliminates the debtor's personal liability but does not alter valid prepetition liens on the debtor's property. If the lien is valid, then the lender does not have to release its interest in the collateral until all loans for which it is security are paid in full.
Strategies for dealing with cross collateralization
file Chapter 13
redeem the collateral under 11 U.S.C. 722
challenge the validity of the cross collateralization in an adversary
proceeding to determine the extent and validity of lien