If you run into financial trouble, you may try to juggle your bills in order to stretch your money as far as possible. Under such circumstances, many financial experts recommend prioritizing debts such as mortgages or insurance, while categorizing unsecured debt (such as credit card bills) as a lower priority. But some credit cards are equipped with a nasty surprise – the capacity to repossess your personal possessions. Even bankruptcy cannot protect you from this potential financial hazard.
Unsecured vs Secured Debt
There are two basic types of debt: secured and unsecured. Secured debt, such as mortgages and car notes, are guaranteed by the merchandise that is being financed. The lender can repossess your house or your car if you don’t maintain current payments. A second type of secured debt is guaranteed by collateral – items or possessions such as jewelry or antiques that the borrower owns that he or she is willing to put up as a guarantee for a cash loan.
By contrast, unsecured loans have only the signed contract to serve as a guarantee of payment. For this reason, unsecured loans are often called signature loans.
Credit card debt is usually classified as unsecured debt. Except for secured credit cards and prepaid cards, credit card companies do not require a guarantee or collateral. Likewise, merchandise that you purchase with a credit card normally is not subject to repossession, even if you don’t pay your credit card bill.
That’s one reason that credit card interest charges tend to be so high. Credit card companies are essentially taking you at your word by issuing you a credit card. In the same vein, interest rates and APRs for cards issued to customers with excellent credit, tend to be significantly lower than those for cards issued to customers with credit that is less than stellar: customers with better credit are usually less likely to default.
The Bankruptcy Stay
Ordinarily, filing a bankruptcy petition triggers a stay, which legally protects your possessions from collection attempts by creditors. Once a stay is in effect, your car, your house, your bank accounts and your personal possessions receive temporary blanket protection from any foreclosure, repossession or seizure. Creditors aren’t even allowed to contact you to demand payment when a stay is in effect.
You shouldn’t consider a bankruptcy stay to be a “get out of jail free” card. It isn’t intended to be a permanent means to allow you to dodge your creditors. Instead, a stay serves to allow you (and your attorney, if you use one) sufficient time to devise a repayment or liquidation plan to pay off or write off your debts. Without a stay, creditors could (and many would) simply seize whatever assets were available, negating the purpose of a bankruptcy petition.
Credit Card Security Interest Clauses Defined
A credit card security interest clause effectively negates many of the protections provided by bankruptcy by essentially converting credit card debt into secured debt. Under the terms of a credit card security interest clause, merchandise that you purchase using the card becomes collateral to guarantee against your default.
In plain English, with a security interest clause in place, credit card companies have the right to seize whatever merchandise you purchase using their cards until you have paid 100 percent of the purchase price, plus whatever interest has accrued during the payoff period.
What’s worse, many credit card agreements include clauses requiring customers to submit to binding arbitration to settle disputes. Under binding arbitration, customers and creditors present their cases to a third party who decides how to settle the agreement – and his or her say goes. Customers have no right to appeal an arbitrator’s decision, and no right to go to court, even as a party to a class action lawsuit.
How Creditors Leverage Security Interest Clauses
Realistically, the odds are slim that a credit card company will physically seize your Jimmy Choos or your Three Stooges DVD box set. Creditors need a court order for a sheriff to enter your residence. Used merchandise can be difficult, if not impossible to sell. Even when used possessions can be sold, it is unlikely that they will command more than a fraction of their original price.
The true value of security interest clauses lies in the fact that they can be leveraged to pressure consumers to make payments. Many consumers will go to extraordinary lengths to pay off or settle credit card debts backed by security interest clauses to avoid losing an essential appliance such as a refrigerator or a stove. The only silver lining is that creditors will often accept market value for their merchandise, which is far lower than the retail price for nearly all items.
Read the Fine Print
Before submitting a credit card application, read the cardholder agreement carefully, including the fine print. Look for terms such as arbitration or repossession, which serve as red flags for security interest clauses. The agreement should be readily available along with the application materials — either on paper or online. You can also find the agreements for more than 300 credit cards on the Consumer Financial Protection Bureau website. You can search the database by credit card provider or even by specific phrases included in various credit card agreements.
If you have questions about any portion of an agreement for a credit card you already have, don’t be afraid to contact customer service. If you don’t like the answers you receive, that’s your clue to consider closing your accounts and seeking credit elsewhere. Especially, if you have decent credit, you have options with more desirable credit terms. An alternative option is to keep the card while avoiding making purchases of merchandise that could be repossessed at a later date. This latter strategy allows you to avoid possibly damaging your FICO score by reducing your amount of available credit.
If you’re applying for credit and have decent FICO scores, you can afford to give cards that carry security interest charges a miss. If your credit is marginal or challenged, you’re likely better off sticking with secured credit cards until your FICO score improves. In either instance, there is no need to tie yourself down to secured credit card debt.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.