Most people think that when they deposit their money in the bank or credit union, either in a checking or savings account, that the money is sitting in a lock box with their name on it, readily accessible at any time. The reality, however, is somewhat different. When you deposit your money in the bank, the cash does not in fact sit in a lock box with your name on it. The bank uses that money to make loans to other customers. After all, that’s how the bank makes money, loaning it out and charging interest. Where do they get the money to do that? From you of course, with the money you have deposited.

So let’s say for example that you deposit $1,000.00 in your checking account at Trusty Bank. Let’s assume that the checking account pays .25 interest. You have in effect loaned the bank $1,000.00 at a very low interest rate. They will then use your money to make a loan to someone else at a much higher interest rate. The difference between the interest rate they pay you and the interest rate they charge on the money they loan out (your money) is their profit.

Now let’s assume that you go to the bank and borrow $1,000.00 and agree to pay the loan back at $100.00 per month. The way the bank looks at it, it’s a wash. They owe you $1,000.00 for the money on deposit and you owe them $1,000.00. So if you ever default on your obligation to pay back the loan, the bank can simply retain the $1,000.00 on deposit and use that money to pay themselves back on the money you have borrowed. This is referred to as the right of set-off.

This can be rather devastating in some situations. For if you miss even a single payment, the bank may have the right to “accelerate” the loan, which means declare the entire amount immediately due and payable. This means that any money you have on deposit can be immediately taken to pay back the full amount of the loan.

It is important to note that this right of set-off is only available if your funds are on deposit with the same bank to whom you owe money. Funds on deposit with a different bank are not subject to the right of set-off. So the lesson is, keep your banking and your borrowing separate. Don’t bank with your creditors.

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