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Note about changes due to COVID-19:
There have been changes to the federal student loan program as a part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) that passed in Congress on 3/27/2020 to help those affected by the Coronavirus.
Until January 31, 2022, borrowers have the option to suspend payments without penalty, if needed. If you are pursuing forgiveness through an income-driven repayment plan, skipped payments will still count towards the time required to be eligible.
You can learn more in our federal student loans guide.
Every month, millions of former college students must make student loan payments to their servicers. Unfortunately for some borrowers, payments can be a huge portion of their monthly income.
In an attempt to reduce monthly payments for borrowers who struggle to keep up with them, the Department of Education has designed several income-driven repayment plans that set federal student loan payments based on income and family size, including:
- Income-Based Repayment Plan (IBR)
- Income-Contingent Repayment Plan (ICR)
- Revised Pay As You Earn Repayment Plan (REPAYE)
- Pay As You Earn (PAYE)
In this guide, we’ll explain what PAYE is, who’s eligible, and how it stacks up against your other repayment options.
In this guide:
- What is PAYE?
- Are you eligible for PAYE?
- Who should consider PAYE?
- Pros & cons of PAYE
- PAYE vs. other income-driven repayment options
- Is PAYE right for you?
What is PAYE?
The PAYE program went into effect in 2012 as part of President Barack Obama’s first student debt relief law. Its goal is to offer extended protections to federal student loan borrowers who struggle with monthly payments.
An income-driven repayment program, PAYE uses your monthly adjusted gross income and family size to calculate a payment amount.
Monthly payments through PAYE
Payments under PAYE are limited to 10% of your discretionary income, but no more than they would be on the standard repayment plan.
The Department of Education defines discretionary income as the difference between your annual income and 150% of the poverty level for your family size and state of residence.
The federal government requires you recertify your income and family size to qualify for the PAYE (or other IDR) plan each year. This means your monthly payments will likely change throughout your repayment period.
Student loan forgiveness through PAYE
The repayment period under PAYE is 20 years. After that, any remaining balance is forgiven.
How much is forgiven depends on what your monthly payments amounted to—it’s possible that you’ll have paid off all or most of your loans by the end of the repayment period.
Typically, the forgiven balance will be taxed as part of your taxable income, so plan ahead for that potential expense.
Are you eligible for PAYE?
Though many borrowers will find they’re eligible for at least one income-driven repayment plan, the PAYE plan has some of the most stringent requirements. Only borrowers who meet the following requirements will be eligible:
- You must be “new borrower,” which means you 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 or consolidated your debt with an application for a Direct Consolidation Loan on or after Oct. 1, 2011.
- Your adjusted monthly payment under PAYE must not exceed that which you would pay under the standard repayment plan. The Federal Student Aid office suggests you’ll likely meet this requirement if your student debt balance is more than your annual discretionary income.
- Your federal student loans cannot be in default.
These 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 after 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?
You may want to consider PAYE for federal student loan repayment if:
- You’re an eligible 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 income without their spouse’s.)
- You’re in a profession that will make you eligible for Public Service Loan Forgiveness (PSLF). To take advantage of PSLF, you must enroll in an income-driven repayment plan.
- Your loans are in default, and you’re using a Direct Consolidation Loan to remove them from default. You must choose an income-driven repayment plan to do so.
Pros & cons of PAYE
- Lower monthly payments than standard repayment.
- Payments will be lower when you have less 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 would have a negative impact on your credit score and bar you from taking advantage of certain federal student loan benefits.
- 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 taxable.
- Interest subsidies are limited to three years for subsidized loans and are not available for unsubsidized loans.
PAYE vs. other income-driven repayment options
The PAYE program isn’t the only income-driven repayment plan available to federal student loan borrowers. Here’s how those stack up.
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.
- 20 years for undergraduate student loans.
- 25 years for graduate and professional student loans.
- 10% of discretionary income.
>> Read More: PAYE vs. REPAYE: Which Is Better for You?
Income-Contingent Repayment (ICR)
With potentially higher payments and a longer repayment term, ICR may not seem like an ideal option; however, it’s one of the only income-driven repayment plans that works with Parent PLUS Loans.
- 25 years
- Whichever is less:
- 20% of your discretionary income.
- The amount you would pay on a repayment plan with a fixed payment over 12 years, adjusted according to your income.
Income-Based Repayment (IBR)
Income-based repayment is similar to ICR, but payments are a little lower, and this plan does not cover parent PLUS loans.
- 20 years for loans borrowed on or after July 1, 2014.
- 25 years for loans borrowed before July 1, 2014.
- 10% of discretionary income for loans borrowed on or after July 1, 2014.
- 15% of discretionary income for loans borrowed before July 1, 2014.
10-Year Standard Repayment
If you do not take any steps toward updating your repayment plan, you’ll default into the standard repayment plan, which aims to repay your loan in 10 years (or 120 payments).
Though monthly payments are higher than with income-driven plans, this plan helps you pay off your loan faster and pay the least amount in interest.
- 10 years (120 payments).
- Fixed monthly payment that spreads your loan balance evenly over 120 payments.
Federal student loan borrowers can also refinance student loans with a private lender at any time. For creditworthy borrowers, refinancing could result in lower interest and significant savings over the life of the loan.
Refinancing federal loans with a private lender will make those loans ineligible for benefits included with Department of Education loans, including income-driven repayment and forgiveness.
Is PAYE right for you?
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 align monthly payments with your monthly budget.
However, PAYE isn’t right for everyone. If you’re considering changing your federal student loan repayment plan, review your options first.
When you apply for income-driven repayment with your loan servicer, you’ll typically have the option to let the servicer place you in the most beneficial plan. Note which plan you’re enrolled in, so you know how it affects your repayment timeline and eligibility for forgiveness.
Author: Jennifer Lobb