The Power of PAYE: Is It the Right Repayment Plan for You?

Ben Luthi

If you’re struggling with your federal student loan payments, there are ways to catch a break.

With income-driven repayment plans, the U.S. Department of Education provides some significant relief to borrowers with unaffordable payments.

The Pay As You Earn plan, or PAYE for short, is one of four income-driven repayment plans.

While it has the strictest eligibility requirements, it can also offer the most relief to people who desperately need it. Here’s what you need to know if you’re considering PAYE.

What is PAYE?

With the Pay As You Earn income-driven repayment plan, your monthly student loan payment will be reduced to just 10% of your discretionary income, and never more than your payment on a standard 10-year repayment plan.

How to calculate your monthly payment on PAYE

Your discretionary income is determined by taking the difference between your annual income and 150% of the poverty guideline for your family size and state of residence.

For example, the poverty guideline for a four-person household in Arizona is $26,200 in 2020. If your annual income is $50,000, you’d here’s how you’d calculate your monthly payment:

  1. Multiply $26,200 by 1.5 to get $39,300
  2. Subtract $39,300 from $50,000 to get $10,700
  3. Multiply $10,700 by 0.1 to get $1,070
  4. Divide $1,070 by 12 to get your monthly payment of $89.17

Each year, you’ll recertify your income and family size to determine whether your monthly payment will go up, down, or remain the same. You’ll also have the option to recertify your income sooner if you want, which can help if your income has decreased suddenly through a job loss, disability, or another reason.

Repayment terms on the PAYE plan

When you switch to PAYE from the standard 10-year plan, your repayment term will be extended to 20 years. This means that while your payment will drop, you’ll likely end up paying more interest on your debt over time.

If you have a remaining balance at the end of the 20-year term, it will be completely forgiven.

However, that forgiven debt will be considered income for tax purposes, so depending on how much is discharged, you may end up with a big tax bill.

Who is eligible for PAYE?

The PAYE plan is designed to assist relatively new borrowers, which means you can’t have any outstanding balances on a Direct Loan or FFEL Program loan when you received a Direct Loan or FFEL Program loan on or after Oct. 1, 2007, and you must have received a disbursement of a Direct Loan on or after Oct. 1, 2011.

You also won’t qualify if your monthly payment on PAYE is higher than what you’re currently paying. As a general rule, you’ll be eligible if your federal loan debt is higher than your discretionary income or matches a significant portion of your annual income.

It’s also important to note that not all federal loans qualify for the PAYE program. If you have any of the following loans, you may be eligible:

  • Direct Subsidized Loans
  • Direct Unsubsidized Loans
  • Direct PLUS Loans made to graduate and professional students
  • Direct Consolidation Loans (loans that were consolidated from Parent PLUS Loans aren’t included)
  • Federal Stafford Loans (if consolidated)
  • FFEL PLUS Loans made to graduate and professional students
  • FFEL Consolidation Loans (loans that were consolidated from Parent PLUS Loans aren’t included)
  • Perkins Loans (if consolidated)

What’s the difference between REPAYE and PAYE?

The Pay As You Earn and Revised Pay As You Earn plans have some similarities, but they also have some significant differences.

For example, they both set your monthly payment at 10% of discretionary income. Also, both plans have a 20-year repayment term, the same loans are eligible, and your remaining balance will be forgiven after your repayment term ends.

With REPAYE, however, there are some key differences.

For starters, your payment can exceed what your payment was on the standard 10-year repayment plan. While this makes it so anyone can apply, it can cause your monthly payments to increase beyond what you’re currently paying in the future.

Also, the 20-year repayment term applies only to undergraduate loans. If you attended graduate or professional school and took out those loans, the repayment term jumps to 25 years.

Finally, REPAYE doesn’t limit access based on when your student loans were disbursed — again, making it possible for anyone with eligible loans to apply.

So the question is: is PAYE or REPAYE better? If you qualify for PAYE based on your income, you’ll get a 20-year term regardless of the type of loans you have, and you never have to worry about your payment going above what you’re currently paying. As a result, PAYE is likely the better option for you.

If you don’t qualify for PAYE, though, REPAYE could still be better than your current situation.

Other income-driven repayment plans and repayment options

While you’re trying to figure out whether PAYE or REPAYE is best for you, take some time also to consider other student loan repayment options. Here’s what else is available.

Income-Based Repayment plan

IBR for short, the income-based repayment plan is another income-driven repayment plan that sets your monthly payment at 10% or 15% of your discretionary income, depending on when you started taking on student loans. The lower percentage applies if you started borrowing student loans on or after July 1, 2014.

Also, the repayment term is extended to 20 years for newer borrowers (on or after July 1, 2014), and 25 years for all other borrowers. There’s no need to consolidate Stafford or FFEL loans to take advantage of this plan.

Income-Contingent Repayment Plan

All federal student loans are eligible for this plan, including Parent PLUS Loans, though some do need to be consolidated first.

With the ICR plan, your monthly payment will be calculated as the lesser of 20% of your discretionary income or what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income. The difference is that your discretionary income is calculated as the difference between your annual income and 100% of the poverty guideline (instead of 150%).

The repayment term for an ICR plan is 25 years, after which your remaining balance will be forgiven.

Public Service Loan Forgiveness

If you have federal loans, you may be able to qualify for forgiveness through the PSLF program. To qualify, you need to get on an income-driven repayment plan and make 120 qualifying monthly payments.

While making those payments, you’ll need to work full-time for a qualifying employer, which includes a U.S. federal, state, local or tribal government agency or an eligible not-for-profit organization.

If you qualify, whatever balance remains after you’ve made 120 payments is forgiven without any tax implications.

Federal loan consolidation

Consolidating your federal loans can help simplify your payment process by combining several loans into one. And if your loans aren’t eligible for an income-driven repayment plan, consolidating can make them eligible.

However, consolidating your loans with the Department of Education won’t save you money. Instead, your new interest rate will be the weighted-average rate across all your current loans, rounded up to the nearest one-eighth of one percent.

Student loan refinancing

If you have good credit and a solid income, you may be able to qualify for a lower interest rate and even a lower monthly payment with a private lender.

Refinancing your loans involves paying off your federal or private (or both) loans with one new loan from a private lender.

Depending on what your current interest rates are and your creditworthiness, you may be able to qualify for a lower interest rate and, therefore, a lower monthly payment. You can also apply for a loan with a shorter or longer repayment term than what you currently have, giving you some flexibility with your repayment strategy and monthly payment.

Compare several lenders — with no impact to you credit score — to ensure you get the best rate and terms available to you.

The bottom line

If you’re struggling to make your federal student loan payments, income-driven repayment plans like PAYE and other repayment options can help you better manage your financial situation.

As you consider which option is best for you, take your time to research each one and how it can help improve your particular situation. Compare the benefits and drawbacks of each option and pick the one that can provide the best path forward for you.

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