Why it's risky to borrow and save with the same bank

Jane Baker explains why banks' right of set off could cause serious financial trauma.

Even though we constantly bang the 'always shop around' drum, many of you still have all your eggs in one basket when it comes to financial products. While that probably means you won't have all the best buy deals, having your savings and debts with the same bank could lead to a far bigger problem...

Financial trouble

Alarmingly, if you run into financial trouble, your bank has the right to raid your savings to settle any outstanding debt repayments. Gulp. Worse still, this also applies if your bank collapses and you owe them money (more on this later.)

It's known as the 'right of set-off' which banks can fall back on without warning. That's right, if you're in debt arrears, your bank can dip into the savings or current account you hold with them without even letting you know first.

That said, the bank only has the right to transfer cash from credit accounts to debit accounts to cover arrears. So if, for example, you have a £20,000 personal loan with Bank XYZ, and you're £1000 in arrears on your payments, the bank could take £1000 from your current or savings account to pay the arrears. But in this example, the bank could only take £1000, not the full £20,000.

Is it fair?

If you borrow money, then it's your responsibility to pay it back. That's fair enough. But I think banks should be lenient, especially in today's economic mess.

Think about it this way: Job losses inevitably rise in a recession, which means more and more of you risk falling into arrears on your debts. The last thing you need is your bank swiping money out of your emergency savings account to settle up missed payments without consulting you first. 

The chances are you'll need to juggle what money you do have until you get back on your feet. But your bank could make a dire situation even worse by clearing out your savings or current account to keep up with debt repayments, potentially leaving you high and dry when you need to pay essentials like your gas bill or council tax.

A last resort

Although banks have an automatic right of set off, the British Bankers Association tells me it is the last resort. After all, banks are required by the Banking Code to treat customers sympathetically. But given that the code is voluntary, I'm fairly sceptical whether such principles translate in practice (Fellow writer, Neil Faulkner is less than impressed with the code too. Find out more in his article.)

In theory, a bank should allow you a reasonable opportunity to pay the debt before raiding your credit accounts, and should only turn to the right of set off when debt repayments can't be met by any other means. But there's plenty of anecdotal evidence which suggests this doesn't always happen.

Joint accounts

So what happens where savings or debts are held in joint names? Do banks still have a right of set off then?

Let's say you have a joint mortgage with your partner which you are 'jointly and severally' liable for. This means you are both responsible for making mortgage payments together and individually. So, if you fall behind and you have a savings account with the same bank solely in your name, then the bank has the right to take money from it to cover the late amount.

The rules are different when it comes to joint savings and sole debts. Thankfully, your bank shouldn't raid a joint savings account to cover missed payments on a debt held in a single name.

What happens if your bank collapses?

As if all that wasn't bad enough, the right of set off also exists if your bank goes bust. In other words, if your bank collapses, it has the right to keep your savings to clear the debts you have with them regardless of whether you're in arrears or not. If your overall debt to the bank is greater than the savings you hold with them, then you may not be entitled to any compensation under the Financial Services Compensation Scheme (FSCS) should the bank fail. (The FSCS protects deposits held with banks up to a maximum of £50,000.)

Let's say you have a mortgage of £150,000 and savings of £50,000 both of which are held with a bank that collapses. When the FSCS assesses your claim for compensation it will look at your net position. You will still owe your bank £100,000 once your savings have been deducted from the total mortgage debt. So, in this example, you won't be able to claim for your £50,000 savings under the FSCS.

This has become a huge concern particularly for borrowers with offset mortgages. In a nutshell, offset mortgages allow the mortgage account and savings account to be linked together to save interest. In other words, savings are notionally used to offset the mortgage debt which reduces the amount of interest charged.  

Often offset borrowers maintain fairly large savings balances to take full advantage of the offsetting facility. But by keeping their mortgage debt and all their savings with the same bank, they are then particularly vulnerable to set-off if things go wrong. (Don't confuse mortgage offsetting with the banks' right of set off!)

Building societies

Just a quick word on building societies: They also have a right of set off but, unlike banks, it isn't automatic. If money can be transferred out of a credit account for set off purposes it must be stated in the terms and conditions.

What should you do if your bank raids your savings?

If you feel your bank has treated you unfairly you have every right to complain. Perhaps you don't think you have been given a fair chance to catch up on missed payments. Remember banks are under more pressure than ever to do the right thing by their customers given the years of irresponsible lending pre-credit crunch.  If the bank rejects your complaint you can appeal to the financial ombudsman.

Of course, this can all be avoided by keeping your savings accounts and your debts separate. 

On a final note, if you're struggling with your mortgage - or any other debt for that matter - read Can't pay your mortgage? Don't panic for tips on how to cope.

Compare all sorts of financial products here.

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