Pay As You Earn (PAYE) helps you pay off your loans more easily by adjusting your monthly payments to the amount you earn right now. If you qualify for the program, enrolling in PAYE can offer significantly easier loan repayment, as well as complete forgiveness of your loan balance after a period of time.
What is Pay As You Earn (PAYE)?
The Pay As You Earn program gives federal student loan borrowers the opportunity to pay back their student loans at a more reasonable pace based on their income. The primary benefit of PAYE is that your monthly loan payments are based on what you currently earn, not on what you owe. Specifically, monthly payments under the PAYE program are capped at 10% of a borrower’s discretionary income.
Part two of this amazing program is that you may not even have to pay off your entire loan. If you make your qualifying payments for 20 years, your federal student loans can be forgiven and discharged.
The most impressive benefits of PAYE are:
- Monthly payments capped at 10% of your discretionary income.
- Loan forgiveness offered after 20 qualified years (discharged amount IS taxable).
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Obama’s Pay As You Earn Repayment Plan
The Pay As You Earn Repayment Plan was passed into law by then-President Obama on December 21st, 2012. PAYE was part of a larger plan to assist those struggling with federal student loans, often referred to as “Obama’s student loan forgiveness program”. This set of law reforms still exists to benefit student loan borrowers in 2018.
The role of PAYE within the larger scheme of new legislation was to make loan repayment easier for graduates when they first enter the workforce and allow them to increase their monthly payments as their income increased.
As it stands, the PAYE program offers more benefits than the other income-driven repayment programs, but it is also harder to qualify for.
Pay As You Earn vs. IBR
The most common type of income-driven repayment plan (the one most borrowers qualify for) is Income-Based Repayment or IBR. The main difference between IBR and PAYE is that your monthly payments could be lower with PAYE than with IBR, depending on when your loan was initiated. This is because, for some loans, monthly payments under PAYE are capped at a lower percentage of your income than they would be under IBR.
PAYE
- Payments generally capped at 10% of your discretionary income.
- 20-year repayment
IBR
- New borrowers on or after July 1, 2014
- Payments generally capped at 10% of your discretionary income.
- 20-year repayment
- Borrowers who are not new borrowers on or after July 1, 2014
- Payments generally capped at 15% of your monthly discretionary income.
- 25-year repayment
Pay As You Earn vs. REPAYE
To help student borrowers who do not meet the more stringent requirements of PAYE, the Obama administration introduced the Revised Pay As You Earn, or REPAYE, program. The primary difference between the two programs is that you can qualify for REPAYE regardless of when your loan was initiated. If you don’t qualify for PAYE, REPAYE can offer the same benefits without many of the limitations.
The repayment term is also different between the two: with REPAYE, you can receive loan forgiveness after 20 years of qualified payments, or 25 years of qualified payments if you’re repaying Grad PLUS Loans.
REPAYE
- Payments generally capped at 10% of your discretionary income.
- 20-year repayment if all loans you’re repaying under REPAYE were received for undergraduate study
- 25-year repayment if any loans you’re repaying under REPAYE were received for professional or graduate study
- Interest forgiveness can be greater in REPAYE
Eligibility Requirements for PAYE
To qualify for IBR, PAYE, or REPAYE, the amount you would pay monthly under the plan must be less than your monthly payment under a 10-year Standard Repayment Plan.
If your calculated monthly payment under PAYE is equal to or greater than what you’re paying monthly with your Standard Repayment Plan, you wouldn’t benefit from PAYE, and you won’t qualify.
In addition to this general requirement, you as a borrower must meet several criteria and make sure your loan qualifies for PAYE.
Borrower Requirements for PAYE
To qualify for the PAYE repayment program, you must meet the following criteria as a borrower:
- Prove at minimum Partial Financial Hardship as defined by the U.S. Department of Education
- Be a new borrower as of October 1, 2007 (defined as having no outstanding balance on a Direct or FFEL Loan when you receive a Direct or FFEL Loan on or after October 1, 2007).
- Have received a Direct Loan disbursement on or after October 1, 2011.
Loans That Qualify for PAYE
Additionally, your loan must be one of the following types of federal loan to qualify for PAYE:
- Direct Subsidized or Unsubsidized Loans made to undergraduate student borrowers
- Direct Plus Loans made to graduate and professional student borrowers
- Direct Consolidation Loans that don’t include PLUS Loans made to parents.
PAYE Limitations:
- Direct Plus Loans made to parents do not qualify for PAYE.
- PAYE only applies to federal student loans that were disbursed on or after Oct. 1, 2007.
- You must not have had a balance on a Direct Loan or FFEL Loan when you received the loan after Oct. 1st, 2007.
Benefits of PAYE
Pay As You Earn is generally harder to qualify for than other IDR plans, but it can result in lower monthly payments and other additional benefits. If you qualify for PAYE, it’s likely the superior choice over IBR.
Lower Payments
The primary benefit of Pay As You Earn is reduced monthly payments. If your monthly loan payment is high, but you’re a new graduate with relatively low income, PAYE may be the best option if you qualify. PAYE caps your monthly payment at 10% of your discretionary income, which can result in a significant decrease in your monthly payment, even lowering it to $0.
Loan Forgiveness
When you qualify for PAYE, you qualify for loan forgiveness after a term of 20 years, as long as you make all of your payments. This is one of the benefits PAYE offers over IBR, since IBR forgiveness is only offered after 25 years for loans taken out before July 1, 2014.
Public Service Loan Forgiveness (PSLF)
If you work in public service, or you plan to go into a public service field, you may qualify for Public Service Loan Forgiveness or PSLF. However, you’ll need to be enrolled in a qualifying repayment plan in order to qualify for this type of loan forgiveness.
Unlike with PAYE and IBR, forgiveness is available after 10 years of qualified payments under PSLF, and any balance forgiven is not considered taxable income.
Enrolling in PAYE is a great option if you’re interested in qualifying for PSLF now or in the future. Not only will you be one step closer to qualifying for PSLF by enrolling in a qualified IDR plan, but you’ll also reduce your monthly payments as much as possible.
Drawbacks of PAYE
While PAYE may seem like a no-brainer, the plan does have drawbacks that are important to consider before enrolling.
Tax Implication for Forgiven Loan Balance
If after 20 years of qualified repayment under PAYE you still owe a balance on your federal student loans, you can qualify for loan forgiveness. However, it’s important to note that this benefit doesn’t come without financial responsibility: any forgiven amount under PAYE is considered taxable income by the Internal Revenue Service. Before applying for loan forgiveness, make sure you’re prepared to pay a percentage of your forgiven balance on that year’s income taxes.
Annual Recalculation and Re-Enrollment
All of the factors included here are recalculated annually in order to determine the fairest repayment amount for every applicant. While this does result in monthly payments that better suit your monthly income, it can also result in a lot of paperwork and hassle.
To recertify your PAYE plan, you have two options: submitting a request electronically via StudentLoans.gov or submitting a paper application through the mail. To make your recertification request, you’ll need proof of income, your spouse’s information if you’re married, your family size information, your signature, and your FSA ID if you plan to use the Federal Student Aid website.
If you’re interested in PAYE, the benefits have to outweigh the time and energy it takes to remain enrolled and keep your information up-to-date.
Debt Prolongment
If you can afford to make your monthly payments under the 10-year Standard Repayment Plan, you can be debt-free in half the time it will take to get out of debt under a PAYE program. Getting out from under your student debt faster may just be worth it, even if it means forgoing the forgiveness offered by the PAYE program if you can afford it.
By reducing or eliminating your student debt in 10 years rather than 20, you better your financial health and will likely have more success when it comes to buying a home, taking out a line of credit, and anything else that requires a credit check.
What Will My Payments Be With PAYE?
Your monthly payments under PAYE are calculated using your discretionary income. Discretionary income is anything your household earns over 150% of your state’s poverty level. To find out what your monthly payments would be if you qualify for PAYE, you’ll need to calculate your household’s discretionary income.
Note that your entire household’s income goes into this calculation, not just your own, as state poverty levels are based on household size.
Check Your Estimated Income-Driven Payment
Example of monthly payment calculation under PAYE repayment plan:
The 2018 Federal Poverty Guideline for the 48 contiguous United States and D.C. was $16,460 for a household of two.
If you’re in a household of two and living in California, making $36,000 per year as a household (both incomes included), you would find your discretionary income by the following:
- 150% of $16,460 (1.5 x 16,460) = $24,690
- $24,690 is 150% of your state’s poverty level.
- $36,000 – $24,690 = $11,310
- $11,310 is your discretionary income.
- 10% of $11,310 (.10 x 11,310) = $1,131
- $1,131 is the amount you owe yearly.
- $1,131 divided by 12 = $94.25
- $94.25 is your monthly payment.
Trump Proposals for Student Loan Forgiveness
It’s 2018, and the president who instated the PAYE and REPAYE programs is no longer in office. However, these IDR plans have yet to experience any changes under the new administration.
Discharged Student Loans Tax Burden
President Trump has made some changes to the way student loan forgiveness works, including the Tax Cuts and Jobs Act, which made discharged student loans untaxable for people who received it for Death or Total and Permanent Disability. The act also eliminated the tuition and fees deduction, which allowed taxpayers to reduce their taxable income by up to $4,000.
Changes to Student Loan Repayment Plans
In addition to these changes which have already gone into effect, Trump has proposed the elimination of IBR, PAYE, REPAYE, and ICR, and the instatement of a single, new income-driven repayment plan.
The new plan would cap borrowers’ monthly payments at 12.5%, which would be an increase for any borrowers who currently qualify for PAYE and REPAYE.
The new plan would also provide student loan forgiveness at 15 years for undergraduate borrowers and 30 years for graduate/professional borrowers. It’s unclear whether or not forgiven balances would be taxable as income.
Is PAYE Right for You?
If you’re struggling to make your monthly payments under a 10-year Standard Repayment Plan, PAYE isn’t your only option. Although PAYE might be the most generous income-driven repayment option, not every applicant will qualify. Additionally, PAYE might not be the best choice for you if you want to pay off your debt faster, or if you’re not prepared to keep up with yearly enrollment.
If you don’t qualify for PAYE or you’re interested in learning more about other income-based repayment plans, click here.
