A customer has a deposit account and a loan with the same bank. Is it generally allowable for the bank to add the customer's deposit account overdraft to the customer's unpaid loan principal balance on a regular basis? I am familiar with the "right of off-set" provision, but do loan agreements generally allow the reverse? (i.e. increase the unpaid loan principal by rolling-over a customer's overdraft) I understand that the terms of the loan agreement may dictate the answer (and I am in the process of securing and reviewing the loan agreement), but generally speaking, is this arrangement the "norm" or an "exception"?

IMO it would be the exception.

This may be more of an exception. I've never heard of this being done before.

And here is something that further complicates the issue --- repayment of the loan is set-up via automatic transfer from this deposit account. But the customer never makes enough deposits during the month to cover the monthly loan payment. So every month or so, after the overdraft amount accumulates, it is wiped-out and rolled into the loan principal and "presto" --- the deposit account starts fresh with a $-0- balance.

Huh - are you talking about a line a credit that is linked for overdraft protection??

No, this is a consumer loan and it's not tied to an overdraft protection program. The customer has a separate installment loan, and the unpaid principal on this loan periodically increases after the bank rolls-over the overdraft balance from the deposit account. I have never seen anything quite like this before, and the reasoning and logic, if any, behind such an arrangement is even more puzzling.

Sounds like you have an officer that is trying to hide a past due loan situation. The safety and soundness regulators are going to be all over you. The loan has not had an actual payment made to it for as long as this has been going on - how far past the point is this loan where it should have been charged off???? If you found one, there may be more. Also make sure this is an active deposit customer and the loan is legitimate. I have seen loan officers book fictitious loans to people with dormant accounts and start pulling automatic payments out of the accounts to cover their tracks. This is either a poor business practice or possible internal fraud. Either way it should be stopped pronto.

This practice needs to cease immediately.

Your bank appears to be:
a - engaging in a practice that hides delinquent credits;
b - capitalizing interest;
c - converting secured debt into unsecured debt;
d - turning closed-end loans into open-end lines, with all
the compliance disclosure and legal collection issues such
an unofficial conversion may entail; and
f - as Randy noted, possibly enabling an embezzlement or money
laundering scheme.

The customer makes deposits to the account (per the account statement), but the deposits are never big enough to cover the monthly loan payment. I plan to verify the source of the deposits as well. I feel much better now (insert facetious emoticon here). Thank you for your comments and insight.