Answer from David: It can be but it's not very prudent as the borrower can empty the account at any time.
Answer from Andy: If you did, you'd want to hold the funds collateralizing the loan. Then the funds are not available for the customer, and it isn't really a demand deposit account. Next, if the borrower writes a check that would access part of your collateral, you are faced with reducing your hold, or returning the check. Early on your decision may be to return the item and charge a fee. But what about when the loan is $100 and the deposit is $1,000? And if you decided to pay an item and maintenance the hold, how many times will you do that before you have spent more in wages than you made in interest? What if an ATM or POS item is force-paid and the funds have to come from your collateral?
My point is that by putting it in a savings account the customer is used to not having access, your work is reduced, your likelihood of losing collateral is reduced and your expendature is not much greater for the interest that they will earn. That can be made up on your loan rate any way. So technically yes it may be used, but that isn't necessarily what you'd want to do.
First published on BankersOnline.com 3/7/11