Every month, millions of college graduates must make student loan payments to their servicer. Unfortunately, for some of those student borrowers, payments can be significantly high when compared to their monthly income.
In an attempt to assist borrowers who struggle with their monthly payments, the Department of Education has designed several income-driven repayment plans, including the Income-Based Repayment Plan (IBR), Income-Contingent Repayment Plan (ICR), Pay As You Earn (PAYE), and Revised Pay As You Earn Repayment Plan (REPAYE).
Under the PAYE program, eligible borrowers can take advantage of lower monthly payments based on their income and family size. However, due to slightly more stringent qualification requirements, only certain borrowers will be eligible for this particular income-driven repayment program.
In this guide:
What Is PAYE?
The PAYE program went into law in 2012 as part of former President Barack Obama’s first student debt relief law. The primary goal of the measure was to offer extended protections to federal student loan borrowers, mainly those who were struggling with their monthly payments.
As an income-driven repayment program, PAYE uses the borrower’s adjusted gross income and family size to calculate a payment amount. Ideally, as the borrower progresses in their professional life, their income will increase and allow them to pay more each year — hence “pay as you earn.”
Under the PAYE plan, borrowers typically make monthly payments set at 10% of their discretionary income, and any remaining balance at the end of their repayment term is forgiven.
Monthly payments under the PAYE program cannot exceed the amount that would be required for a repayment term of 10 years under the standard repayment plan. Borrowers must also qualify for a partial financial hardship.
Monthly Payments Through PAYE
One of the defining characteristics of the PAYE plan is the monthly payment cap, which is set at 10% of the borrower’s discretionary income.
Discretionary income is defined as any income that is not used to cover essential living expenses like housing, utilities, and food. According to the Department of Education, discretionary income is defined as the difference between the borrower’s income and 150% of the current poverty level for their existing family size and state of residence.
In addition, interest on their student loan balance is not capitalized unless they become ineligible for the PAYE program.
Because your income and family size can change from year to year, the federal government requires borrowers to recertify their PAYE plan each year. As such, your monthly payments can change over the course of your repayment period.
Forgiveness Through PAYE
Another prominent characteristic of income-driven repayment plans, including PAYE, is loan forgiveness. Borrowers who are enrolled in and maintain monthly payments under the PAYE plan are eligible for student loan forgiveness after 20 years.
However, it’s important to note that the remaining balance is considered taxable income, you may be required to pay taxes on the remaining balance depending on your situation.
Am I Eligible for PAYE?
Though many borrowers will find they’re eligible for at least one income-based repayment plan, the PAYE plan carries more stringent requirements when compared to other options. Only borrowers who meet the following requirements will be eligible:
- You must be “new borrower,” which is defined as someone who has received a loan after Oct. 1, 2007; if you have a balance for a federal student loan that was disbursed prior to this date, you will not be eligible.
- You must have received a Direct Loan disbursement on or after Oct. 1, 2011.
- Your adjusted monthly payment under the PAYE program must not exceed that which you would have paid under the Standard Repayment Plan.
- Your federal student loan debt is higher than your annual discretionary income or represents a significant percentage of your annual earnings.
In addition, your federal student loans cannot be in default status. Further, only the following loans qualify for repayment under PAYE:
- Direct Stafford Loans (Subsidized & Unsubsidized)
- Grad PLUS Loans
- Direct Consolidation Loans made after Oct. 1, 2011, as long as they do not include Direct or FFEL (Federal Family Education Loan program) loans made before Oct. 1, 2007
The following loans are eligible only if they are consolidated into a Direct Consolidation Loan:
- FFEL Subsidized Federal Stafford Loans
- FFEL Unsubsidized Federal Stafford Loans
- FFEL PLUS Loans for graduate or professional students
- FFEL Consolidation Loans that did not include PLUS Loans
- Federal Perkins Loans
Who Should Consider PAYE?
Just because you might qualify for PAYE doesn’t mean it’s the best federal student loan repayment option for you. However, you may want to consider PAYE if any of the following apply:
- You’re a “new” borrower and you’re currently struggling to make your monthly loan payments.
- You’re married but only want your individual income considered for repayment. (Under PAYE, married borrowers filing taxes separately can calculate payments based on their individual income as opposed to your spouse’s income, too.)
- You’re eligible for Public Service Loan Forgiveness (PSLF). In order to take advantage of PSLF, you must enter one of the available income-driven repayment plans.
- Your loans are in default status and you’re planning on using Direct Loan Consolidation to remove them from their current status. In order to do so, you must choose an income-driven repayment plan.
Pros and Cons of PAYE
The PAYE program, like other federal student loan repayment plans, has both its benefits and downsides. Benefits include:
- Lower monthly payments
- Payments capped at 10% of your discretionary income
- Interest subsidy for the first three years (If your monthly payment doesn’t cover the monthly interest on subsidized loans, the government will pay the remaining interest for three years.)
- Can help you avoid delinquency or default, which can have a negative impact on your credit score and bar you from taking advantage of certain federal student loan benefits
Meanwhile, the potential disadvantages of the PAYE program include:
- Borrowers who took out loans before Oct. 1, 2007, will not qualify
- PAYE extends your repayment period and thus increases the interest you pay over the life of your loan
- Any forgiven balance is considered taxable income
- Interest subsidies are limited to three years for subsidized loans and are not available for unsubsidized
The PAYE program isn’t the only income-driven repayment plan available to federal student loan borrowers.
Revised Pay As You Earn (REPAYE)
For some borrowers, the revised version of PAYE, known as REPAYE, may be more beneficial. This income-driven payment plan was launched in 2015 in an effort to increase eligibility among federal student borrowers.
Like PAYE, you will be expected to make payments equal to 10% of your discretionary income; however, both old and new borrowers may be eligible, regardless of their income level or when the loans were disbursed. Further, REPAYE offers more generous interest subsidies than PAYE.
>>Read More: PAYE vs. REPAYE: Which is Better for You?
Income-Contingent Repayment (ICR)
Unlike PAYE and REPAYE, borrowers who choose ICR will be expected to make payments that are either 20% of their annual income or the equivalent to what they would pay under a fixed, 12-year repayment plan based on their AGI (adjusted gross income). In addition, the repayment term for ICR is 25 years.
With potentially higher payments and a longer repayment term, this may not seem like an ideal option; however, it’s one of the only income-driven repayment plans that are eligible for borrowers with Parent PLUS loans.
If you do not take any steps towards updating your repayment plan, you’ll automatically enter into the Standard Repayment plan. Under this plan, you will have 10 years to repay your loan and payments will be fixed over the course of the term.
Though monthly payments are typically higher than those that accompany any of the income-driven repayment plans, the Standard Repayment plan can help you pay off your loan faster and keep interest from ballooning.
Federal student loan borrowers can also choose to refinance student loans with a private lender at any time. For highly qualified borrowers, doing so can often result in lower interest rates and significant savings over the life of the loan.
If you’re considering refinancing federal loans with a private lender, it’s important to note that doing so will make you ineligible for any benefits currently offered by the federal government. This includes access to loan forgiveness, income-driven repayment plans, and the ability to put your loans into forbearance.
For some borrowers, the savings are enough to merit the risk; however, once loans are moved to a private lender, there is no going back. As such, the decision to refinance federal loans with a private lender should only be made after a careful and thorough analysis of the pros and cons as they relate to your unique financial situation.
Choosing the right student loan repayment plan can make it easier to manage your debt obligations. As an income-driven repayment plan, PAYE is designed to provide borrowers with monthly payments that are reflective of their current income amount and family size. In most cases, this results in lower payments.
However, PAYE isn’t right for everyone. If you’re considering changing your federal student loan repayment plan, take the time to review your options on StudentLoans.gov or reach out to your loan servicer for additional guidance.
Author: Jennifer Lobb
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