It doesn't happen often, but lenders technically can tap deposit accounts to make up loan payments.
Borrowers who've missed a mortgage loan payment to a bank or credit union where they also have a checking or savings account might want to move their money. The right is rarely exercised, but these institutions technically can tap those accounts to get late payments and more, according to Jeffrey A. Schreiber of The Schreiber Law Firm in Marion, Ind.
"You may want to think twice, if you get into financial problems, about keeping your money in the same bank that you owe money to on any kind of loan," Schreiber says.
The bank's right to use a borrower's deposit account to make up past-due payments is known as the "right of offset," Schreiber says.
A similar right may be tucked into mortgage loan documents or deposit-account papers signed by the borrower, explains Shari Olefson, an attorney with Fowler White Boggs in Fort Lauderdale, Fla., and author of "Foreclosure Nation," a book about the U.S. foreclosure crisis.
Offset Right Rarely Used
Even with the right, banks don't often exercise the offset against homeowners. Here are some reasons that's the case.
- If the borrower doesn't have a deposit account at the bank that owns the loan, that bank must get a court order to locate accounts at other institutions, Olefson says. That may be not be worth the effort, since the legal fees to track down and retrieve the funds could total more than what the defaulted homeowner has in his or her accounts.
- Lenders sell most mortgages to investors. Those secondary-market transactions transfer the interest in the loan but not the right of offset. In practical terms, this disconnect means a homeowner whose mortgage loan has been sold to Fannie Mae or Freddie Mac probably doesn't need to be concerned that the lender might tap a deposit account to recoup missed payments. However, the same cannot be said for homeowners who have a nonconforming loan that's still on the lender's books.
"Those who have been advanced money based upon nonconforming loans where the bank still is servicing and has possession of that note must be aware of it. But most mortgages are sold on the secondary market, so that's really not an issue," Schreiber says.
A bank may be quicker to offset when a loan involves a commercial property or expensive home, Olefson says. High-net-worth individuals also may face a greater risk since they're more likely to do all their banking through one institution that offers special services to such customers. In some cases, such borrowers are required to keep a large deposit account at the institution as a condition of a loan.
"They underwrite outside of the normal boxes, but they want to hedge their risk by having the borrower keep (his) deposit account there," Olefson says.
Loan servicers generally aren't in contact with local bank branches. This departmentalization means the servicer probably doesn't have access to the borrower's banking information or to the process in place to exercise the right of offset.
Ties may be closer at smaller banks and credit unions, which, Schreiber says, tend to be more aggressive about tapping deposit accounts to make up missed mortgage loan payments.
"Credit unions are famous for setting off accounts. They're much more aware of how much money is in the accounts because they're smaller and there's a more intimate relationship," he says.
Lenders may be reluctant to exercise the right of offset due to customer service and reputation considerations, says Nessa Feddis, vice president and senior counsel at the American Bankers Association, an industry group in Washington, D.C.
"It's not a customer-friendly thing," Feddis says. "In a lot of cases, they want to give the customer a chance at paying on their own."
If a lender opts to use a right of offset, the amount normally won't be limited to missed loan payments. Late fees, penalties, default interest and, if the loan is accelerated, the entire outstanding balance could be claimed from the borrower's accounts. Essentially, any money in a personal account is fair game, though certain types of business or retirement accounts may be off-limits. In addition, state laws also may govern some rights of offset.