PAYE (Pay as You Earn) Student Loan Repayment Explained
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Summary:
Pay as You Earn is a type of income-driven repayment plan designed to help borrowers with federal student loans who are struggling to make payments. It also qualifies you to receive loan forgiveness after 20 years if there is a remaining balance. If you work in certain sectors of the public service, your federal student loans could be forgiven in as few as 10 years.
So you’ve graduated from college and want to start your career. It’s an exciting time, but it’s also time to start thinking about your federal student loan payments. Student loan debt is not as exciting, but it’s a fact of life for millions of students. On the upside, unlike private student loans, federal loans have more flexible repayment options.
Depending on how much you owe, the standard plan of 10 years can seem intimidating and overwhelming. But there are other options that will take into account what you make when calculating your monthly payment. The Pay as You Earn (PAYE) plan is your best option if you want the lowest possible monthly payment, but it can be difficult to qualify for. Let’s take a look a closer look at how it works and if you are eligible.
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What is the PAYE repayment plan?
Pay as You Earn (PAYE) is a type of income-driven repayment (IDR) plan only for federal student loan borrowers. Your monthly loan payments are capped at 10% of your discretionary income. However, these payments will never exceed what the regular monthly payment would be under the 10-year standard plan.
The repayment period is 20 years. If there is a remaining student loan balance at the end of that period, your loan will be forgiven. However, you may be able to have your loans forgiven after 10 years if you are eligible for the Public Service Loan Forgiveness program (PSLF).
Loans included in the plan are Direct subsidized and unsubsidized loans as well as Direct consolidation loans. Direct PLUS loans for parents, whether they are Direct loans or Federal Family Education Loans (FFEL), are not included.
What is discretionary income?
Discretionary income is the money that remains after taxes and other deductions are removed from your paycheck, and you pay for necessary living expenses.
The Federal Student Aid (FSA) office further describes it as the difference between your annual income and 150% of the poverty guideline for your family size and state of residence. They use that number for the purposes of calculating your eligibility for enrolling in the PAYE repayment program.
Do you qualify for a PAYE payment plan?
Not everybody qualifies for a PAYE payment plan. Here are the requirements:
- New borrower. You must be a “new borrower.” Specifically, you must have taken out only Direct loans after October 1, 2007, and have had no federal student loans prior to that date. You also need to have received a federal loan disbursement on or after October 1, 2011.
- Financial hardship. Financial hardship is calculated by looking at your income in relation to the cost of living in your state, and the size of your family. If you have kids, for example, you have a better chance of qualifying.
- Yearly certification. To remain eligible, you need to recertify each year. While this seems like a small step in the process, it is very important that you meet this deadline every year.
What happens if I miss the annual deadline for recertifying my income and family size?
If you fail to make the deadline, you may be subject to a number of unfavorable outcomes. This includes being removed from the PAYE payment plan (leading to increased payments), additional interest, and missed tax benefits.
- Increased payments. You may get kicked out of your plan and moved to the standard plan with higher monthly payments.
- Capitalized interest. If you miss the deadline and are on one of the PAYE, REPAYE, or IBR plans, any unpaid interest will be capitalized and added to your principal balance. Obviously, this adds to the total cost of the loan.
- Missed tax benefits. If you don’t recertify your family size, your loan servicer will assume you are a family of one. So, you will miss out on a possible lower monthly payment based on your family size.
REMEMBER! Though capitalized interest will be added to your loan balance should you leave the PAYE plan, this interest is capped at 10%. This benefit is unique to PAYE, so keep that in mind when comparing repayment plans.
Are my forgiven student loans considered taxable income?
The answer to this is sometimes. If you are a federal student loan borrower and are eligible for PSLF, you will not be taxed on the remaining balance of your loan.
However, if your federal student loans are forgiven because you’ve made qualified payments on an income-driven repayment plan (like PAYE) for 20 to 25 years, the forgiven money is considered income. You will need to report this income on your federal income tax return.
IMPORTANT! You may not have to count your forgiven loans as income if your student loans are discharged or canceled, such as for total and permanent disability. However, it’s best to speak with your loan servicer or a licensed financial professional to see if you meet the qualifications.
How to apply for the PAYE
Before you do anything, it’s a good idea to talk to your loan servicer to decide which payment plan is best for you. Then you’ll need to fill out the Income-Driven Repayment Plan Request form. You can mail it if you like, but it’s faster and easier to do it online.
When you apply, you’ll need to provide income information to determine your eligibility for certain plans and to calculate your monthly loan payments depending on which plan you choose. Use your adjusted gross income if you’ve filed a federal income tax return in the last two years and your current income hasn’t changed significantly since your last tax return. Otherwise, you will need to provide alternative documentation of income.
What are the pros and cons of PAYE?
The PAYE payment plan is a great option for many students who struggle with their monthly payments under the standard plan. However, this plan is not without its drawbacks.
Is Pay as You Earn right for you?
If you qualify for PAYE, have a relatively low income, and high federal loan debt, the PAYE plan might be the best choice for you. However, consider whether you expect your income to increase rapidly. If your income increases substantially, you may no longer qualify for PAYE. In that case, you might want to consider an alternative income-driven repayment plan.
You should also consider how much interest you may pay through a PAYE plan. Because PAYE plans have longer loan terms (20 years instead of 10 years), this means you will probably pay more interest than with a standard plan. If you can manage the higher monthly payments, you could save money through a standard plan. This is especially important if you are not eligible for other student loan forgiveness plans.
With this is mind, it can be worthwhile to review other income-driven payment plans to see if one of those is a better fit for you.
Pro Tip
If you are eligible for public service loan forgiveness, try to make your student loan payments under a qualifying income-driven repayment plan — you will need to make 120 qualifying payments to qualify for loan forgiveness.
What are other income-driven repayment plans?
Outside of PAYE, there are three types of income-driven repayment plans. Keep in mind that defaulted loans are not eligible for any income-driven repayment plans.
Before you make a decision, talk to your loan servicer about your concerns. Remember that you can change your plan at any time.
| REPAYMENT PLAN | REPAYMENT TERMS | ELIGIBILITY |
|---|---|---|
| Revised Pay As You Earn Repayment Plan (REPAYE) | Payments are 10% of your discretionary income, with the remaining balance to be forgiven after 20 years (or 25 for graduate loans) | Borrowers with direct subsidized loans and direct unsubsidized loans, as well as those with PLUS loans to the student |
| Pay As You Earn Repayment Plan (PAYE) | Payments are 10% of your discretionary income, but never more than you would have paid under the Standard Repayment Plan | All borrowers after 2007 |
| Income-Based Repayment Plan (IBR) | Payments are either 10% or 15% of your discretionary income, with the remaining balance to be forgiven after 20 years (or 25 for graduate loans) | Borrowers with a high debt relative to their income |
| Income-Contingent Repayment Plan (ICR) | Payments are 20% of your income or the amount you would pay on a fixed payment over 12 years, with the remaining balance to be forgiven after 25 years | Borrowers with direct subsidized loans and direct unsubsidized loans, as well as those with PLUS loans to the student |
Do repayment plans consider your spouse’s income?
In most cases, your spouse’s income will not impact your monthly student loan payments unless you jointly file your income taxes. The only IDR plan that does not follow this step is the REPAYE plan. Below is a quick review of the four IDR plans and how they determine monthly payments when you are married.
| Repayment Plan | Income Considered When Married Filing Jointly | Income Considered When Married Filing Separately |
|---|---|---|
| Revised Pay as You Earn | Joint Income | Joint Income |
| Pay As You Earn | Joint Income | Individual Income |
| Income-Based Repayment | Joint Income | Individual Income |
| Income-Contingent Repayment | Joint Income | Individual Income |
Alternatives to income-driven repayment plans
If you aren’t eligible for income-driven repayment plans or your loans are older, you still have a few other choices when looking for an alternative student loan repayment plan.
First, consider getting a Direct consolidation loan, so you’re only dealing with a single monthly payment. Then, you might want to explore some of the following options.
Extended repayment plan
The extended repayment plan allows you to pay your loan over an extended period of time. It’s not eligible for forgiveness, but it can keep your monthly loan payments low. This plan might be best if you don’t expect to see big bumps in your pay over time and you carry a high loan balance.
To qualify for this plan, you can’t have had outstanding Direct loan debt prior to October 7, 1998, or on the date you got a Direct loan after October of 1998. The same is true of an FFEL.
The repayment period is 25 years and your minimum debt to qualify for the plan is $30,000 for each loan. If, for instance, you had $15,000 of debt with a Direct loan and $15,000 with an FFEL, you would not be eligible.
Graduated repayment plan
A graduated repayment plan starts out with low payments, but they increase every two years. This is a good idea if you’re not making a lot of money right now, but expect sizable increases over the years.
Both FFEL and Direct loans are eligible for this plan. The repayment period is 10 years for individual loans, but up to 30 years when you have consolidation loans. There is no minimum debt amount to qualify for this loan repayment plan.
Refinancing
Another option when repaying your debt is to refinance. However, refinancing eliminates your chances of having the loan forgiven. You’ll also lose out on some of the protections that come with federal government loans.
On the other hand, if you’re okay with these downsides, make a healthy income, and have a great credit report, you might actually be able to save some money on interest.
At what age does a student loan get wiped?
Unfortunately, contrary to some dubious sources, there is no magical age when federal student loan debt gets forgiven, canceled, or discharged. You can get your student loans forgiven, but it has nothing to do with your age.
Key Takeaways
- PAYE is a type of income-driven repayment plan for federal student loans that allows for low monthly payments and forgiveness after 20 years.
- The PAYE plan is only for newer student loan borrowers who took out loans after October 1, 2007.
- PAYE and some of the other income-driven repayment plans are also eligible for PSLF — talk to your loan servicer if this is a possibility for you.
- Direct loan borrowers should consider an alternative income-driven repayment plan if they don’t qualify for the PAYE plan.
- The portion of your loan that’s forgiven may count as taxable income and you must claim it on your federal income tax return.
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