Beware the Dangers of the Graduated Repayment Plan

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When you’re facing a long road to student debt payoff, it may be tempting to ignore your monthly statements and assume that putting your bills on autopay is the best way to debt freedom.

But if you’re serious about getting rid of debt, it’s crucial to scrutinize your statements every month. On the federal graduated repayment plan, for instance, the way payments are applied at first means the amount you pay may not be enough to shrink your balance as fast as you’d like.

If you view your balance regularly and want to get rid of loans more quickly, you could decide to switch repayment plans or accelerate payoff on your own.

Here’s what you need to know about the graduated repayment plan if you’re on it, or considering it, and how it might affect your loan balance. Specifically, we’ll look at:

How the graduated repayment plan works

The graduated repayment plan sounds like a useful option: It keeps your student loan payments low in the first few years post-graduation and gradually increases them over time. Ideally, your income will increase as your career progresses, and your payments can rise the same way.

Graduated plans are typically 10 years with an increase in your bill every two years. Borrowers with direct consolidation loans can get a 30-year plan. There’s also an extended graduated repayment plan, which gives borrowers up to 25 years to pay off loans.

Review your graduated repayment plan carefully

There’s a downside to receiving lower payments the first few years out of college. Payments are lower initially because they’re interest-only. That means your payments are applied only to interest as it accrues, not to the principal balance, and as a result, your balance does not decrease.

Knowing how the graduated repayment plan works can help you take the lead on debt payoff. If you put an extra $50 toward payments each month, you can make progress on your balance even if your minimum payment goes only toward interest. To do so, you’ll need to read the fine print on the plan before you choose it and keep an eye on your monthly statements.

Lower payment plans slow down debt payoff

There are many repayment plans designed to lower your monthly payment.

Besides the first few years of the graduated repayment plan and extended graduated repayment plan, income-driven plans can also reduce payments to a percentage of income. They can be a massive help if you’re on a tight budget, since they free up money for necessities like food, shelter and utilities.

But they can also slow down payoff. In the case of income-driven plans, your payments may not cover the total amount of interest that accrues, meaning your balance increases. Income-driven plans provide forgiveness at the end of your repayment term, but you’ll be taxed on that amount, which means that higher balance could lead to a major tax bill in the end.

Get back on the payoff track

If you’re on a plan that lowers your monthly payments, don’t switch plans immediately. These plans can be advantageous if your budget is already tight, you’re still in job-hunting mode or you’re paying down high-interest consumer debt.

But if you don’t know whether the graduated repayment plan is working for you, consult your student loan servicer about other options. You may wish to change your own repayment schedule, potentially by switching to bimonthly student loan payments, which can help chip away at the balance faster by allocating one extra loan payment per year toward loans.

Also consider refinancing your student loans, especially if you’re in the position now to make larger monthly payments than you were in the past. You’ll need good-to-excellent credit or a cosigner to qualify, but refinancing could leave you with a lower interest rate, giving you more room to allocate additional money to loans each month.

When you’re ready to make loan payoff a priority, check out our student loan prepayment calculator and start creating a plan of attack.

Anna Davies contributed to this report.