Setting up an automatic monthly debit for student loans is usually a relatively simple process with most lenders. Many even offer a slightly reduced interest rate as an incentive for auto-debits. Is giving a student loan servicer the authority to auto-pay student loans a good idea?
In many cases, automatic payments can be a good idea. However, these payments need to be part of a broader loan repayment strategy. Borrowers using a “set it and forget it” approach may be making a huge mistake.
Automatic payments come with several risks that borrowers need to understand before enrollment. Those who understand and avoid the dangers of auto-payments will be able to save money and streamline student loan repayment.
The Big Benefit of Auto-Pay: Lower Interest Rates
Most student loan companies offer a .25% interest rate reduction.
Saving a fraction of a percent on interest won’t be life-changing, but there is some value here. A borrower with a $30,000 student loan balance will save $75 per year. For more significant balances, the .25% savings adds up. A borrower with a $100,000 student loan balance can save $250 per year.
The thing for borrowers to consider is whether or not the savings is worth the potential headache. Providing checking information to a student loan lender comes with serious concerns. They could have their data hacked. The payment may change, causing an account to be overdrawn. The lender may make a mistake with the payment.
Can I Trust My Lender to Manage Automatic Payments?
Trusting any financial services company with access to your money comes with risks. Fortunately, there are ways to mitigate those risks.
I have authorized my student loan servicer to make withdrawals from my checking account. To protect myself from the lender taking out too much money, I have put some protections in place.
Ways for borrowers to prevent issues:
- Set up a checking account just for auto-payments – Many people have automatic payments set up with multiple lenders. Auto-Debits may have also been approved for other utilities and services. Using one account for just these payments allows for streamlined supervision of these companies.
- Don’t put too much money in your auto-pay account – Shady activity by a student loan company or a computer error can cause a larger than expected withdrawal to be made. Getting this corrected can take time. Don’t leave yourself vulnerable to missing a rent payment because your student loan company took out too much money.
- Don’t connect your checking account to a savings account – Many checking accounts have overdraft protection. Often they will pull the money out of a savings account to cover the shortage in the checking account. Tell your bank not to do this with your auto-pay checking account. If the accounts are connected, the student loan company has access to your savings.
Many banks and credit unions offer completely free checking accounts. If you sign up for an account with no minimum balance and no monthly fee, you can transfer money each month into your new auto-pay checking account. This extra step protects more of your money from lender errors.
The Hidden Danger: Lazy Repayment
Making the minimum payment on all of your student loans is one of the worst ways to repay student debt. Minimum payments extend the time it takes to pay off the loans, and it maximizes spending on interest. The ideal customer in the eyes of most lenders would be the one who makes the minimum payment every month for the life of the loan. These “set it and forget it” customers provide lots of profit for minimal effort.
One of the best ways to repay student debt is to make minimum payments on all loans and attack one loan with as many extra payments as possible. This route minimizes interest spending and eliminates the debt as quickly as possible.
Automated payments enable borrowers to be really smart in repayment or really dumb.
As long as borrowers make auto-debits part of their student loan repayment strategy, they will be fine. If the only payments made are via auto-debits, borrowers will be spending more than necessary on their student loans.
Watch Out for Lender Nonsense
Some lenders make the use and enrollment in auto-pay very simple. Others make it unnecessarily complicated and collect late fees from borrowers who make a mistake.
Enrollment can be tricky – Some lenders will say that it takes 20 days for the enrollment to go through. Others say that it can take two full billing cycles. This delayed system can put borrowers in a bind. Do they have to set up the next payment manually? When does the auto-debit start? Is there a way to prevent paying twice?
Don’t auto-debit on the last day possible – Some lenders will only allow borrowers to auto-debit on the very last day of the billing cycle. This creates a major issue for borrowers. If there is an issue with the computer process or their bank, the borrower could be charged a late fee even though they did nothing wrong. When possible, try to schedule payments to give yourself several days to address any issues that might arise.
Should I Auto-Pay My Student Loans?
Whether or not auto-pay makes sense will depend upon the individual borrower.
Those that want to use automated payments as part of a larger strategy for debt elimination can undoubtedly benefit.
Those who might be tempted to set up auto-debits and forget about their student loans may be better served by sticking with manual payments.