How to Use Automatic Payments Without Racking up Overdraft Fees

A big questions you might be asking yourself is, “should I pay my bills automatically?”

The answer might surprise you. Setting up automatic payments or debits from your checking account might seem like a great idea, but for some, it can be costly.

I hear from readers who tell me they set up auto-pay to make sure their bills are getting paid on time, and to make their lives easier.

It sounds like it makes sense, right? But instead of making their lives easier, they get hit with costly overdraft fees. Today in this article, I wanted to address when and if you should set up automatic payments or debits, and how to set it up in a way that actually benefits you.

First, let's talk about the fundamentals.

• Read: I Tracked Every Penny I Spent for 30 Days and This Is What Happened

AUTOMATIC DEBITS VS AUTOMATIC PAYMENTS

Automatic debit payments work a little differently than the recurring bill-pay featured offered by your bank, also known as automatic payments.

If you decided to set up recurring bill pay through your bank, you are permitting them to send payments on your behalf to the company that you owe via a check.

If you set up automatic debits from your checking account, you are giving the company you owe permission to take the money directly from your checking account.

Whichever one you decide to use to pay your bills, it's essential that your finances are set up in a way that works best with either method. But if you're not careful, and aware of your finances, it can end up costing you some money.

• Read: The Right Way to Balance a Checkbook

DRAWBACKS OF AUTOMATIC PAYMENT

It's important that you know that auto-pay does not work for everyone. If your checking account is on the verge of $0 most of the time, setting up auto-pay can be tricky.

Bills that vary from month-to-month make it hard to estimate how much to keep in your checking account to cover the bills.

I heard from a reader last month who told me their utility bill almost doubled the usual amount, and she didn't realize it until after her checking account was already overdrawn, and by then her bank already charged her a $15 overdraft fee.

If you have multiple different debit cards or credit cards for auto-pay, it can be a headache to find out that one expired and your bill was never paid. An expired card can leave you with a late payment fee from your debtor. This can also lead to a dip in your credit score. With your payment history making up 35 percent of your FICO score, this can lead to some major problems if you are trying to buy a home or vehicle.

The same holds true if you have all of your bills tied to one card. Once your card expires, you have to make sure your payment information is updated for each debtor. Talk about a pain in the tush!

• Read: Have Irregular Income? Here's How to Budget for It.

BENEFITS OF AUTOMATIC PAYMENT

There is no doubt that auto-pay is convenient. You no longer have to visit several different websites or flip through several mailed invoices to pay your bills every month. If set up through your bank, it can also be an excellent way to organize and view all of your bills in one place. Some banks will even email you when they are about to send a payment, which means they are essentially coming to you instead of you to them.

One of the biggest benefits for auto-pay is that it ensures your bills get paid on time. As mentioned above, payment history is important if you want to improve your credit score. It is the single biggest component of your FICO credit score, and if you show good payment history for an extended period of time, those delinquent marks for late payments on your credit report can eventually fade over time.

WHEN SHOULD YOU USE AUTO-PAY?

The “set it and forget it” strategy only works if you are disciplined enough to check your balance in your bank account on a regular basis. This is especially important if you have no financial cushion.

You should only use auto-pay if you are successfully using a budget, and you are completely aware of where you are financially. That means keeping track of all of your bills and payments and making sure the right amount is being charged.

Most people have a hard time paying their bills when their due dates are spread throughout the month. To make things easier, and to ensure that you have sufficient funds to cover your bills, I suggest calling your debtors and asking to change the due date. If all of your bills are due on the 1st, it's a lot easier to determine how much money to set aside for your auto-payments, and when to have the money available.

Most banks offer services that will alert you if your bank account balance dips below a certain level. If you have auto-pay, you need to set this up right now! You can choose to have these alerts sent in an email or text, and in most cases, you can determine the minimum balance amount.

If you receive an alert, check your budget or bill tracker and make sure you don't have any bills coming out, or when the next bill is scheduled to leave. A bill tracker is something that I use in addition to my budget, and it's a quick list for me to reference that has all of my bills, their due dates, and the amount owed. It's a simple way to for me to see what's going on in my financial world.

• Read: How to Calculate Your Net Worth

KEEP IN MIND

Make sure you contact your bank as well as the company you are paying too see how long it takes for payments to process. If you are mailing a check with automatic payments, this is crucial information. If your payment is due on the 5th, but it takes ten days to process, you don't want to set up automatic payments for the 4th, even though it's technically before the due date.

For bills that are the same amount month-to-month, I suggest setting up automatic payments through your bank. This will ensure that you keep multiple accounts in one place. For the few bills that vary month-to-month, like a credit card or utility bill, I suggest setting up automatic debits through the debtor. This will guarantee that the full amount owed is being paid. Some financial experts suggest not using auto-pay for variable expenses, due to the high risk that the bill amount might be significantly different than what you were expecting. If you do decide to auto-pay for your variable expenses, make sure you have a financial cushion in your checking account to cover any difference.

Lastly, if you decide to use auto-pay, do not take a “set it and forget it” or “out-of-sight, out-of-mind” approach. Paying your bills this way is meant to simplify your life, but it also takes discipline. If you are not careful, it can have the opposite effect on your finances.

Do you use automatic payments? Why or why not? I would love to hear about it in the comments below!

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