Why it matters

Set-off changes how safe your bank balances are when you owe money to the same lender. If your loan contract includes a set-off clause, the bank can combine or freeze accounts and withdraw funds to reduce what you owe—sometimes without a court order. That can disrupt payroll, vendor payments, or household bills.

How set-off works (plain steps)

  • Contract step: Most commercial banks include a set-off or “right of combination” clause in account agreements and loan documents. If you default or breach, the lender can apply your deposits to the debt.
  • Trigger step: Common triggers are missed payments, declared default, insolvency, or a formal demand for payment specified in the loan agreement.
  • Execution step: The lender identifies eligible accounts held at the same institution, places holds or freezes, and transfers funds to the loan balance.

What funds can be taken

  • Typical targets: checking, savings, money-market accounts, and other deposit accounts the borrower holds at the same bank.
  • Potential limits: Some funds are protected or treated differently. For example, federal benefit payments (like Social Security) have special protections under 42 U.S.C. § 407 and may be exempt from seizure—check rules before assuming set-off is allowed (see govinfo.gov for the statute). For consumer-focused guidance, see the Consumer Financial Protection Bureau (CFPB) on bank set-off practices.

Who decides whether set-off is allowed

  • Contract: The first place to look is your loan agreement and the bank’s deposit account terms. Those documents usually spell out the lender’s rights and any notice requirements.
  • State law and common law: When the contract is silent, state law (including common-law set-off and statutes) can create or limit a lender’s rights.
  • Federal protections: Federal statutes can override contractual set-off in some situations (for protected benefits or bankruptcy cases).

Real-world examples

  • Small business line of credit: A business misses payments on a line of credit at Bank A. Bank A withdraws funds from the business checking account at Bank A to cover the past-due balance under the set-off clause.
  • Personal loan and payroll timing: A borrower’s paycheck clears into an account at the same bank after a missed loan payment. The bank immediately applies the deposited paycheck to the loan, leaving the borrower with no funds for bills.

Common misconceptions

  • Misconception: “Banks can take any money anytime.” Reality: They need a contractual right or legal basis; federal protections and some account-holder agreements may limit action.
  • Misconception: “FDIC insurance prevents set-off.” Reality: FDIC insurance protects deposit balances up to insurance limits if a bank fails; it doesn’t stop a bank from exercising a lawful set-off while it is operating.

Practical steps to reduce risk

  • Read agreements: Before signing loans or opening accounts, scan for phrases like “set-off,” “right of offset,” or “right of combination.”
  • Separate accounts: Keep large operating cash or protected funds in an account at a different bank that is not the borrower’s creditor.
  • Negotiate contract language: For business loans, ask for limited set-off rights or an exception for payroll and tax accounts.
  • Keep lenders informed: If you face cash flow problems, contact the lender early. Many will agree to forbearance or amended terms rather than sweep accounts and escalate collection costs.
  • Seek legal help: If you suspect improper set-off, consult a consumer attorney or finance counsel promptly.

How set-off differs from garnishment and levy

Set-off is a private contractual or common-law right allowing a bank to use funds it holds to satisfy a debt owed to it. By contrast, garnishment and levies are court- or government-ordered seizures (for example, tax levies or court judgments). For a deeper look at these differences and options to respond, see FinHelp’s guides on loan default consequences and how wage garnishment works:

Frequently asked practical questions

  • Can a bank take Social Security deposits? Federal law (42 U.S.C. § 407) generally protects Social Security benefits from seizure; banks and collectors must follow that protection. Ask your bank in writing if your deposited benefits are safe.
  • Will the bank notify me before taking funds? Loan agreements vary. Some require notice; others allow immediate application. Even when notice isn’t contractually required, state law or bank policy may impose notice requirements.
  • Can I prevent set-off if I file bankruptcy? Bankruptcy can halt most collection actions, including set-off in many cases; however, Bankruptcy Code rules are complex—discuss with a bankruptcy attorney.

Authoritative sources

  • Consumer Financial Protection Bureau (CFPB): guidance on bank set-off and account freezes (consumerfinance.gov)
  • Legal overview of set-off: Cornell Legal Information Institute, Wex “Set-off”: https://www.law.cornell.edu/wex/set-off
  • Federal protection for Social Security: 42 U.S.C. § 407 (see govinfo.gov)

Professional disclaimer

This entry is educational and not legal or financial advice. For advice tailored to your facts, consult a lawyer or licensed financial professional.

Last updated: 2025 (verify state law and your loan documents for current rules).