If you qualify, the Pay As You Earn Plan (PAYE) Program can limit your student loan forgiveness to 10% of your discretionary income and provide total student loan forgiveness after 20 years of consistent payments.
Pay as You Earn (PAYE), at times called the Obama Pay As You Earn Program, actually became legislation in December 2012. Designed to aid graduates and former students with federal student loans acquired on or after October 1, 2007, PAYE was the first student debt relief program signed by the then First American Black President – Obama.
How the PAYE Does lowers your monthly costs?
The default repayment method for student loans is a 10-year Standard Repayment Plan. Payments are determined based on the loan balance under this option. Sadly, this will prove unaffordable if your loan balance is on the high side but your income is low.
Under PAYE, payments are not determined by your loan balance. Rather, PAYE will “reduce your payment to 10% of your discretionary income and will cap your monthly payment.
The difference can be small. Consider the difference between standard repayment if you have a $35,000 student loan balance at 5.7% interest; your income is $20,000 and grows 3.5 percent annually; and you are single.
|Repayment term||~ 10 yr.||~ 20 yr.||~10 yr.|
Most times, your monthly payments under Pay as you earn student loans aren’t enough to cover interest increasing on loans. Under both PAYE and IBR, interest is not capitalized – or added to the principal balance – until you are done with the program, as explained by the Department of Education.
But, under PAYE, unpaid interest is only capitalized until the principal increases by 10%. This cap is a substantial benefit, because when interest is capitalized, you pay interest upon interest.
Under both PAYE and IBR, low payments also mean you often won’t repay your loan even after so many years. You’ll have the remaining amount forgotten under both, as long as you made all your payments. PAYE offers loan forgiveness after 20 years, but the IBR Payments on loan taken before July 1, 2014, must be made for 25 years before loans are forgiven. The interesting thing is that, under both PAYE and IBR, you will have to pay taxes on the amount forgiven.
How your monthly payment is calculated under PAYE
To calculate your payment under PAYE, begin by figuring out your discretionary income. To calculate your discretionary income, subtract 150% of your state’s poverty level from your household income. State poverty levels are based on household size.
The poverty level for a household of one in NY (New York City) was $12,060 in 2017, according to New York State Community Action Association. If you are single and living in New York with a $20,000 income, you would subtract $18,090 ($12,060*1.5) from $20,000. Your discretionary income would be $1,910. Your payments would be equal to 10 percent of this amount, so you’d owe $191 a year or $15.91 monthly.
The simplest way to calculate your PAYE payment – and its payment method – is to use our Student Loan PAYE calculator.
To use the calculator:
- Input your adjusted gross income
- Pick your family size
- Choose the state you reside in
- Enter information about your current student loan balance and student loan interest rate.
- Estimate how much you expect your income to grow annually. The historical average income growth is around 3.5 percent, so that’s what our calculator defaults to.
The calculator will display your monthly payment, your savings, the forgiven amount, and the total amount repaid.
Eligibility requirements for PAYE
Before you begin to see Pay as you earn repayment plan application, there are some requirements you should know about.
PAYE demands that borrowers and their loans pass strict eligibility requirements. These include but not limited to:
- You must have received a Direct Loan disbursement on or after October 1, 2011.
- You must be a new borrower as of October 1, 2007. You are not eligible if you had an outstanding balance on a Direct Loan before October 1, 2007.
- The payment you’d owe under PAYE must be smaller than the payment you’d make if you were on the 10-year Standard Repayment Plan.
- Your loans must qualify for a PAYE plan. Qualifying loans include Direct Subsidized and Unsubsidized Loans, Graduate PLUS Loans (but not Parent PLUS Loans) and consolidation loans made after October 1, 2011, as long as the consolidation loans do not include Direct or FFEL Loans made before October 1, 2007.
And now you know the requirements before applying for the PAYE repayment plan forgiveness.
Advantages of PAYE
The Pay as you earn repayment plan forgiveness has some core benefits for borrowers. The biggest one being that you could have a mountain-full pile of debt forgiven after paying 20 years. For some that could be millions or hundreds of thousands of dollars.
Other pros include but not limited to:
Ability to cap ad reduce your payments
Has better interest subsidies and capitalization rules than IBR, and
Flexibility to file taxes to keep payments low
Disadvantages of PAYE
The bad side to PAYE includes Pay as you earn repayment interest rate that is less favorable than REPAYE, which could really mean bad news for people with higher loan balances. Additionally, Since your payments are lower to begin and paying over a longer period than a standard 10-year repayment plan, you will end up paying more interest.
There is also the risk of PAYE not always remaining an option. This is because these loan forgiveness programs were established under President Obama’s presidency. Any administration could take it away. Since you don’t get the benefit until you’ve paid in 20 years, there is a big risk that the benefit will be there.
REPAYE: A Pay As You Earn expansion
If you are not eligible for PAYE, you may be qualified for REPAYE, which was a Pay As You Earn expansion. This program extends PAYE to all federal student loan borrowers.
The year 2015 witnessed the Revised Pay as You Earn Repayment Plan being brought to life by the Department of Education.
This modified version of PAYE allows more borrowers to qualify because you can become eligible regardless of when you took out your loans.
But, REPAYE and PAYE have important uniqueness in how they treat spousal income and how student loan interest is treated.
Under PAYE or IBR, a student loan debtor can file taxes separately from a spouse and the spouse’s income won’t count for determining loan payments. This option goes away under REPAYE and a spouse’s income factors into determining REPAYE payments per month.
REPAYE offers better help with interest to borrowers whose interest passes their monthly payments. If your loans take on $100 in interest per month and you pay only $50, your student loan balance would increase even as you made payments. REPAYE creates room for borrowers to have 50 percent of excess interest forgiven monthly. This means you’d only have $25 in monthly interest added to your loan balance each month if you paid $50 and monthly interest in the amount of $100 accrued.
But, there are no monthly payment caps under REPAYE, so your payments could end up much higher than they would on the Standard Repayment Plan.
Is Pay As You Earn right for you?
Whether Pay as Your Earn repayment plan (PAYE) is right for you or not highly depends on your “borrowers-perspective”. However, we recommend you take the following factors seriously before applying:
- current loan balance
- current income
- spousal loan balances
- where you work
- expected future income, and
- spousal income
You’ll need to ensure you are eligible for PAYE, estimate your present and future income, use our Pay as you earn calculator to project payments, and decide which option makes sense both now and in the future.
Also, PAYE could be an ideal option for eligible borrowers going for public service loan forgiveness, because it is the most aggressive option for lowering payments.
A good example of someone who might want to do PAYE would be a married borrower with high loan balances, who is going for PSLF, and whose spouse has no loans and high income.
But, if your income is higher and does not have a spouse, you can take advantage of refinancing over PAYE.
It’s just a matter of running the math to discover how to keep your overall costs of Pay as you earn repayment plan student loans low and to find out if PAYE student loans is the best answer for you.