If you’re struggling with high student loan payments, switching to the Pay As You Earn (PAYE) plan could help make your monthly dues more affordable. PAYE is an income-driven repayment (IDR) plan for federal student loans. Eligible students on the PAYE plan can have monthly payments on qualifying federal student loans reduced to 10 percent of their discretionary income. After 20 years of payments, any remaining loan balance will be forgiven.
PAYE is one of several IDR plans that are ideal for student loan borrowers having difficulty making monthly payments. PAYE — along with the Revised Pay As You Earn (REPAYE) plan — does more than just reduce monthly payments. Opting for PAYE as your student loan payment plan could mean you don’t have to repay your entire loan balance.
If you’re interested in having your student loan payment adjusted for your income, read on to learn more.
What is Pay As You Earn?
“[PAYE is] a type of income-based repayment option where the amount you pay will be based on your discretionary income,” Michael Solari, the certified financial planner for Solari Financial Planning, LLC, explained. “The idea is that your payments will be less as you enter the workforce and gradually grow as you earn more.”
Federal student loan borrowers can choose the PAYE repayment program if they struggle to make normal loan payments. For qualifying borrowers, the repayment plan limits payments to 10 percent of discretionary income. At the end of a 20-year repayment term, any outstanding loan balance is forgiven as long as no payments were missed during the term.
PAYE differs from traditional Income-Based Repayment (IBR) because, depending upon the date your student loans were initiated, PAYE may cap loan payments at a smaller percent of income than IBR. This means monthly payments would be lower under PAYE. PAYE could also result in earlier loan forgiveness and better interest benefits for subsidized loans.
“If you qualify for PAYE, it is always superior to IBR,” said Chase Branham, an associate financial planner at Wrenne Financial Planning. However, qualifying for PAYE is more challenging, and loan consolidation may be required before you apply.
How PAYE 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. Unfortunately, this isn’t affordable if your loan balance is high but your income is low.
Under PAYE, payments are not determined by your loan balance. Instead, PAYE will “reduce your payment to 10 percent of your discretionary income and will cap your monthly payment,” Branham explained.
The difference can be substantial. Consider the difference between PAYE and 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.|
Often, your monthly payments under PAYE aren’t enough to cover interest accruing on loans. Under both IBR and PAYE, interest is not capitalized — or added to the principal balance — until you leave the repayment program, as explained by the Department of Education.
However, under PAYE, unpaid interest is only capitalized until the principal increases by 10 percent. This cap is a substantial benefit, because when interest is capitalized, you pay interest on the interest.
Under both IBR and PAYE, low payments also mean you often won’t repay your loan even after decades. You’ll have the remaining balance forgiven under both, as long as you made all your payments. PAYE provides for loan forgiveness after 20 years, while IBR payments on loans taken before July 1, 2014, must be made for 25 years before loans are forgiven. However, 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, start by figuring out your discretionary income. Discretionary income is calculated by subtracting 150 percent 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 New York 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 easiest way to calculate your PAYE payment — and the savings this payment method provides — is to use our Student Loan PAYE calculator.
To use the calculator:
- Input your adjusted gross income
- Select your family size
- Select your state of residence
- Input 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 show your monthly payment, the forgiven amount, your savings, and the total amount repaid.
Pay As You Earn (PAYE) Calculator
Because your salary can change annually and PAYE is based off how much you make, you’ll need to recertify your plan each year. To recertify, you will need to provide proof of income. Your payment can go up as you earn more, but will not be more than 10 percent of your discretionary income.
Eligibility requirements for PAYE
PAYE requires that borrowers and their loans pass strict eligibility requirements. These include the following:
- The payment you’d owe under PAYE must be less than the payment you’d make if you were on the 10-year Standard Repayment Plan.
- 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.
- You must have received a Direct Loan disbursement on or after October 1, 2011.
- 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.
Pros of PAYE
PAYE has some significant benefits for borrowers. “The biggest pro is that you could have a ton of debt forgiven after paying 20 years,” Solari said. “For some that could be hundreds of thousands of dollars.”
Other pros, according to Branham, include “the ability to reduce and cap your payments, more favorable interest subsidies and capitalization rules than IBR, and flexibility to file taxes to keep payments low.”
Cons of PAYE
Cons of PAYE, according to Branham, include an interest rate that is less favorable than REPAYE, which could really hurt people with higher loan balances. Further, Solari points out that “since your payments are lower to start and paying over a longer period than a standard 10-year repayment, you will pay more interest.”
Solari also pointed out another big con: the risk that PAYE will not always remain an option. “These loan forgiveness programs were established under President Obama’s presidency. Any administration could take it away,” he warned. “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 eligible for REPAYE, which was a Pay As You Earn expansion. “This program extends PAYE to all federal student loan borrowers,” explained Steven J. Richardson, a student loan lawyer at Richardson Law Offices. However, as Richardson explains in a comparison of PAYE and REPAYE, REPAYE has some cons that PAYE doesn’t.
In 2015, the Department of Education introduced the Revised Pay As You Earn program, also known as REPAYE. This modified version of PAYE allows more borrowers to qualify because you can become eligible regardless of when you took out your loans.
However, PAYE and REPAYE have important differences in how they treat spousal income and how student loan interest is treated.
Under IBR or PAYE, 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 monthly REPAYE payments.
REPAYE provides more help with interest to borrowers whose interest exceeds their monthly payments. If your loans accrue $100 in interest monthly and you pay only $50, your student loan balance would increase even as you made payments. REPAYE allows 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.
However, 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 PAYE is right for you or not is “highly borrower-specific,” Branham said. Factors Branham recommended considering include: “current loan balance, current income, expected future income, spousal income, spousal loan balances, and where you work.”
You’ll need to make sure you are eligible for PAYE, estimate current and future income, use our PAYE calculator to project payments, and decide which option makes sense both now and in the future.
Branham suggested PAYE could be a good 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,” he said.
However, if you have a higher income and neither spouse can take advantage of public service loan forgiveness or interest subsidies, Branham recommended refinancing over PAYE. “Basically at that point, you have to pay off loans, so refinancing to a lower rate can make sense,” he said.
It’s just a matter of doing the math to find out how to keep your overall costs of student loan repayment low and to find out if PAYE is the best answer for you.
Interested in refinancing student loans?Here are the top 6 lenders of 2019!
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.36% APR (with Auto Pay) to 7.82% APR (with Auto Pay). Variable rate loan rates range from 2.41% APR (with Auto Pay) to 6.99% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of April 17, 2019, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 04/17/2019. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on our student loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for SoFi.
3 Important Disclosures for Laurel Road.
Laurel Road Disclosures
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the fixed rate will decrease by 0.25%, and will increase back up to the regular fixed interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.45% effective May 10, 2019.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.41% – 6.99%1||Undergrad & Graduate|
|2.41% – 7.89%2||Undergrad & Graduate|
|2.43% – 6.65%3||Undergrad & Graduate|
|2.38% – 6.81%4||Undergrad & Graduate|
|2.41% – 8.19%5||Undergrad & Graduate|
|2.60% – 9.60%6||Undergrad & Graduate|