When my wife and I were looking to get pre-approved for a mortgage, we started at the most obvious spot: Bank of America, the longtime home of our checking and savings accounts. Turns out, that may not have been a smart idea.
For starters, we were surprised to discover that their rates and terms were pretty unattractive, especially for first-time buyers like us. We were already scrounging for cash, and the bank was pretty inflexible about the down payment amount. The more competitive rates would require us to pay points (those big upfront fees you pay to lower the long-term interest rate on a mortgage), too. The real deal breaker, though? Bank of America wasn't a participating lender in our state's first-time home buyer program, so we ultimately moved on to a community bank that was.
But whether or not you're a first time homebuyer, there's another reason to think twice about getting a mortgage at the same place you do your everyday banking, whether it's a big bank or even your local credit union: The right of offset. This little law allows banks to pull money out of your checking or savings account if you're late on a loan payment, such as your mortgage. It can happen for other bank-serviced loans like car payments, too.
In some cases, a bank could even do this without warning, wreaking further financial havoc on an already cash-strapped customer. Imagine making the difficult choice to put off your mortgage payment after getting laid off, saving what money you have left for food ... and then having it unexpectedly vanish from your account.
Now, this probably doesn't happen as often as it could—lenders use the rule at their discretion, which is usually when all other approaches fail. And some states limit the practice: In California, for example, banks can't touch the last $1,000 in your account to prevent the above scenario. Federal law also prevents banks from using the right of offset for credit card debt. But it's still a risk worth thinking about, even if you can't imagine yourself falling so far behind (few people, if any, expect to default on a loan, but sh*t happens).
But knowing whether you're vulnerable to right to offset is important, because a lender can only legally take funds out of another account if your loan agreement specifically authorizes it, says Richard Barenblatt, mortgage specialist with GuardHill Financial Corp. Nobody likes fine print, but reviewing your loan document will be worth the slog, as that's where you'll find any mentions of a "right to offset" clause. If you have an electronic version of the document, just do a simple Command-F or Control-F search for "offset" or "setoff" to see if you've agreed to it unknowingly.
Additionally, some banks only do this if your accounts are linked, says Elise D. Leve, senior loan officer at Citizens Bank, where this applies. "The bank cannot yank the money out of your bank account unless you are set up for auto-deduct," she says. Leve says if you're not set up for auto-deduct and default on your loan, then the bank will notify you that the account is entering into a formal pre-foreclosure process.
So, in the case of Citizens Bank, the workaround seems simple: Just don't link your accounts, right? Well, the bank offers its customers a 0.125 percentage point discount on their mortgage if you link accounts and sign up for autopay—making it pretty likely that you would link your accounts to get the savings. Other banks like Fifth Third sometimes offer this as a special promotion.
To be sure, there are advantages to keeping your financial business at one institution—like that mortgage-rate discount. If it's easy for the bank to shift money from your checking account to your mortgage, it will probably be nice and easy for you, too. If your credit score isn't very good, a longtime relationship with your local credit union might sway them to be more flexible on their lending criteria.
And if you're flush with cash but disorganized or forgetful, well, you might prefer your bank to just reach into your account if you miss a payment, rather than suffer a hit on your credit score.
If you do get a loan from your primary bank, one way to protect yourself from the right of offset is to keep an emergency fund or secondary checking account at a separate financial institution. An online bank is a good option, since they're easy to open and often have higher interest rates than traditional savings accounts. Ally and Capital One 360 Money Market are two of the biggest and most established online banks.
But if you qualify for your state or city's first-time home buyer program, your best bet is probably to find a community bank or credit union that participates in it. These programs can offer low down payment options, credit score flexibility—even benefits like down payment assistance and mortgage insurance should you lose your job. Sounds a whole lot nicer than yanking money out of your account out of the blue, right?