What is the Pay as You Earn Plan for Federal Student Loans?

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Pay As You Earn is an income-driven repayment plan that can lower your federal student loan payments. (Shutterstock)

Pay As You Earn (PAYE) is an income-based repayment plan that can help make your monthly federal payment student loan more manageable payments. Here’s what you need to know about the Pay As You Earn plan, who’s eligible, and how to apply.

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What is Pay as You Earn (PAYE)?

Pay as you earn is a income-contingent reimbursement plan (IDR) offered by the US Department of Education that can reduce your federal student loan payments. It caps your monthly student loan payment at 10% of your discretionary income, which the Department of Education defines as the difference between your annual income and 150% of the poverty level for your state and family size.

The remaining balance of your student loan will be forgiven if you have not fully repaid your loans at the end of PAYE’s 20-year repayment period. But if you meet the requirements of Civil Service Loan Waiver (PSLF)the remaining balance of your loan can be canceled after only 10 years of qualifying payments.

To qualify for the PAYE plan, you must show partial financial hardship, which means your payment would be less with PAYE than the standard repayment plan amount.

You must continue to make your regular federal student loan payments until you are approved for PAYE. Once you’re enrolled in the PAYE plan, you’ll need to recertify every year — even if your income or family size hasn’t changed — or you could be removed from the program.

And it’s important to understand that your loan balance may actually increase while you’re on a PAYE plan. This can happen if your monthly payment amount is not enough to cover the interest you owe and the lender capitalizes the unpaid interest. Compounding means that the lender adds your unpaid interest to the principal balance of the loan.

How do you qualify for PAYE?

To qualify for PAYE, you must meet the following criteria:

  • You must be a new borrower on or after October 1, 2007.
  • If you took out a direct or FFEL loan on or after October 1, 2007, you did not have an outstanding balance on another direct or FFEL loan at that time.
  • You received funds for a direct loan or direct consolidation on or after October 1, 2011.
  • The payment you make under PAYE, depending on your income and family size, is less than what you would pay under the standard 10-year repayment plan.
  • You have a subsidized direct loan, an unsubsidized direct loan, a PLUS direct loan as a graduate or professional student, a consolidation direct loan that has not repaid any PLUS loans granted to parents, an FFEL loan or a federal loan Perkins.
  • Your federal student loans are not in default.

It is important to note that PAYE does not have a maximum income limit. It considers how much you earn relative to your federal student loan debt rather than how much you earn as a standalone number.

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When the PAYE plan might make sense for you

PAYE can be a great option in some situations. You may want to explore this repayment plan if any of the following apply to you:

  • You do not expect a significant increase in your income. If you currently don’t earn much but receive a huge raise down the road, you may not be able to requalify for PAYE.
  • You are alone. Since two incomes can make it harder to prove partial financial hardship, PAYE may be easier to qualify if you’re single.
  • You have low income and large loan balances. If you don’t earn much but have a lot of federal student loans to pay off, PAYE can make your monthly payments more manageable.
  • You have a big family. With this reimbursement plan, the cost of living in your state (which is based on your family size) matters. If you have children, it may be easier to prove partial financial hardship.

Advantages and disadvantages of PAYE

As with all IDR plans, PAYE has pros and cons to consider.

Benefits

  • It reduces your monthly payment to 10% of your Discretionary Income.
  • Any remaining loan balance can be canceled after 20 years (or 10 years with PSLF).
  • Your spouse’s federal student loans are also taken into account, which can make eligibility easier.

The inconvenients

  • If your income increases significantly in the future, you may not be able to continue making payments under the PAYE plan.
  • You will be liable for taxes if your federal student loan balance is canceled under PAYE. But if your loan is canceled between December 31, 2020 and January 1, 2026, the canceled amount will not count as taxable income, thanks to a provision of the American Rescue Plan Act.
  • If you opt out of the PAYE plan, your student loan payment may increase.

PAYE vs. other income-driven reimbursement plans

The Pay As You Earn plan isn’t the only option for repaying federal student loans. The Ministry of Education offers three other IDR plans to choose from. The repayment plan you choose affects the amount of interest you’ll pay over the term of the loan (although interest rates on federal student loans are generally lower than interest rates on private student loans). To learn more about IDR plans, visit Federal Student Aid website.

Pay As You Earn Review

  • Monthly Payment Amount — 10% of your discretionary income
  • Mandate’s duration – 20 years for undergraduate loans; 25 years for college or vocational loans
  • Eligible loans — Subsidized and unsubsidized direct loans, direct PLUS loans granted to students, direct consolidation loans which do not include PLUS loans (direct or FFEL) granted to parents
  • When interest capitalizes — If you voluntarily leave the plan or do not recertify

Income Based Reimbursement (IBR)

  • Monthly Payment Amount — 10% of your discretionary income if you are a new borrower on or after July 1, 2014; 15% of your Discretionary Income if you are not a new borrower on or after July 1, 2014 (both payment amounts will not exceed the standard 10-year repayment plan amount)
  • Mandate’s duration – 20 years if you are a new borrower on or after July 1, 2014 (or 25 years if you are not a new borrower on or after July 1, 2014)
  • Eligible loans — Direct Subsidized and Unsubsidized Loans, Subsidized and Unsubsidized Federal Stafford Loans, Student PLUS Loans, Consolidation Loans (Direct or FFEL) which do not include Parent PLUS Loans
  • When interest capitalizes — If you are no longer in partial financial hardship, do not recertify or voluntarily leave the plan

Income Contingent Reimbursement (ICR)

  • Monthly Payment Amount — Either 20% of your Discretionary Income or what you would pay on a repayment plan with a 12-year fixed payment (whichever is lower)
  • Mandate’s duration – 25 years
  • Eligible loans — Direct Subsidized and Unsubsidized Loans, Direct Student Loans PLUS, Direct Consolidation Loans
  • When interest capitalizes — If you do not recertify

How to apply for PAYE

You can complete the PAYE application process online by following these steps:

  • Go to the IDR plan request page on the Federal Student Aid website.
  • Click “Login to Get Started” under the “New Applicants” section.
  • Log in with your FSA ID, which is the same ID you used for the FAFSA when you originally applied for federal student loans.
  • Complete the application, which usually takes 10 minutes or less.
  • Connect the request to your IRS tax form or submit the most recent copy of your tax form to your student loan officer.
  • Enter your income into the loan repayment calculator.
  • Select the PAYE plan if you qualify.
  • Enter additional personal information and submit your application.

Alternatives to PAYE and Income-Based Reimbursement Plans

If an IDR plan isn’t right for you or you don’t qualify, consider these other ways to manage your student loan debt:

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