How Has PAYE Changed for 2016?
Big time! As of Tuesday, October 27th, 2015, PAYE is being updated to allow over 5,000,000 (5 million) more signups, and this is great news for those of you who have been waiting to get into the plan.
President Obama’s Administration recently announced that they are officially relaxing the eligibility rules to allow people with loans from before October, 2007 to enroll in a new student loan repayment plan, which they’re now referring to as REPAYE (short for “Revised” Pay As You Earn).
This is a huge change and a great step in the right direction for anyone who would benefit from enrolling in the best Federal income-based repayment plan on offer, including many hundreds to thousands of people who visit this site.
Updates to President Obama’s Previous Student Loan Reforms
One of the most controversial issues surrounding President Obama’s student loan forgiveness program has been its exclusion of anyone who borrowed before October, 2007, but that’s finally being wiped out, and older borrowers will be able to join the plan come December, 2015.
This is an excellent opportunity to help reduce your monthly student loan payments, and one that you will definitely want to look into and consider.
To enroll in the new REPAYE program, you’ll need to visit www.StudentAid.gov/IDR, or contact whoever services your loan and express interest in moving to the new plan. They are legally mandated to help walk you through that process, so don’t worry about getting the run around.
Oh, and before I forget, you do NOT need to pay anyone anything to get onto this new repayment plan. Any company who contacts you offering to get you into it for a fee should be summarily dismissed, as you can complete the entire process entirely on your own with a single phone call!
Why Should You Sign Up for PAYE/REPAYE?
The PAYE and REPAYE repayment plans are significantly better than all of the other Income-Based Student Loan Repayment Plans (including IBR, ICR, etc.), since they offer the earliest loan forgiveness, and the lowest monthly payments.
Virtually anyone who qualifies for these plans will have a lower monthly payment than they would on any other Federal repayment plan, and the only downside to them is that they could lead you to owing more money in the long-run if you aren’t paying enough to cover your interest charges each month.
Before you enroll in PAYE or REPAYE, make sure to do your homework, run the calculations, and figure out whether or not the plan truly is the best fit for your particular financial situation.
TPresident Obama reaffirmed his conviction that all Federal student loan holders should be eligible for the PAYE plan by December, 2015 in his recent “Student Aid Bill of Rights” announcement.
And that’s a great thing, because PAYE offers two major benefits to those eligible for the plan, including:
- Early loan forgiveness (total Federal loan forgiveness after just 20 years of making payments)
- Low monthly payments (monthly payments are limited to just 10% of discretionary income)
The best way to take advantage of PAYE remains enrolling in the plan while also signing up for the Public Service Loan Forgiveness Program, which would allow you to qualify for total student loan debt forgiveness after making just 10 years of monthly payments, and paying no more than 10% of your discretionary income during that time.
In fact, because PAYE is income-based, it’s possible that you could even qualify for complete Federal Student Loan Forgiveness after 10 years, even if your payments are set at $0 per month during that entire time period.
PAYE is an extremely powerful repayment plan, and combined with the PSLF program, can work wonders for those of you facing terrible student loan situations.
What is PAYE?
Perhaps the biggest benefit to President Obama’s Student Loan Reforms was the introduction of the Pay As You Earn Student Loan Repayment Plan, commonly referred to as “PAYE”.
Compared to the previously available Student Loan Repayment Plans, the Pay As You Earn program is substantially more affordable in short-run, typically offering significantly lower monthly payments.
If you’ve got student loan debt, and especially if you’ve got a lot of it, you will most certainly want to evaluate the benefits of this new loan repayment plan.
What Does PAYE Do?
The Pay As You Earn plan caps monthly student loan payments to just 10% of discretionary income, which means that if your discretionary income were $1,000 per month, then your maximum student loan payment would be just $100.
What that means is that your monthly payments will fluctuate over time (the amount is recalculated and reset each year), rising and falling as you make more (or less) money.
That’s a great temporary solution for people with extremely high debt to income ratios, but it do present some long-term downsides since this structure could end up costing you quite a bit of coin over the long-haul (more on that in a bit).
How are Monthly Payments Calculated?
Once you’re enrolled in the Pay As You Earn student loan program, your monthly payments will be calculated according to a precise formula based on the following factors:
- Your income and family size (larger families means lower monthly payments)
- Adjustments each year to changes in your annual income and family size
- Scheduled according to a 20 year repayment term
Monthly payments under this plan are guaranteed to be less than the standard 10-year repayment plan, and are usually lower than the payments offered by any of the other plans as well.
To get a precise idea of just how much your PAYE monthly payments will be, head on over to the Government’s official Repayment Calculator, plug in the appropriate values, and you’ll know exactly what to expect.
What Loans Are Eligible for PAYE?
Only some Federally-funded student loans (Direct loans) are eligible to enroll in the Pay As You Earn student loan repayment plan.
Here’s a list of the Federal student loans that are eligible for the PAYE program:
- Direct Subsidized and Unsubsidized Loans
- Direct PLUS loans made to students
- Direct Consolidation Loans, but not Direct or FEEL PLUS loans issued to parents
Here’s the real kicker though – only certain types of borrowers (referred to as “new borrowers”) with these types of loans can sign up for the plan.
Who are “New Borrowers”?
The Federal Government defines “New Borrowers” as individuals who meet the following criteria:
- New Borrowers did not owe any money on federal student loans as of October 1st, 2007, AND
- New Borrowers have received a qualifying federal student loan disbursement on or after October 1st, 2007
What’s that mean?
If you had loans before October 1st, 2007, you won’t be able to enroll in the PAYE plan, unless you first pay those loans off entirely, then take out a new loan and use PAYE to pay off that new loan.
This leaves the vast majority of those holding federal student loan debt out of contention for leveraging the Pay As You Earn plan, and it’s by far the biggest limiting factor in this program’s attempt to provide effective Debt Relief for Federal Student Loan Debt.
But the qualifications don’t stop there, because in addition to being a “New Borrower”, you must also have what the Government calls a “Partial Financial Hardship” in order to qualify for eligibility.
What is a Partial Financial Hardship?
To qualify for the Pay As You Earn plan, you’ll need to prove that you’re facing a partial financial hardship, but what does that mean?
A partial financial hardship is defined as existing when the amount of money you owe on your loans each year, as calculated under the standard 10-year repayment plan, exceeds 10% of your “discretionary income”.
What’s discretionary income?
Discretionary income is defined as your annual income, minus the poverty guidelines for your family size.
To find out if you’re facing a partial financial hardship, add up the amount of money you owe on eligible student loans (including only Federal Direct loans and FEEL Loans), calculating this amount according to the 10-year Standard Repayment Plan, then check to see if that exceeds 10% of the difference between your adjusted gross income and 150% of the poverty line for your family size in the state where you live.
If you do qualify, then you’ll be able to enroll in the PAYE plan, but if you don’t, you’ll have to look elsewhere for debt relief.
Note that it’s much easier to qualify for a partial financial hardship if you’ve got a large family size, but if you’re making decent (or great) money and simply spending too much of it, then you probably won’t make it through this eligibility filter.
If you’re a public service worker with a high debt to income ratio, then you’ll probably qualify easily.
If you’re a recent law school graduate with hundreds of thousands of dollars in Federal student loans, then you’re almost guaranteed to qualify.
The easiest way to find out whether or not you qualify is to enter your information into the Government’s official and online Repayment Estimator.
Pros & Cons of PAYE
To tell you the truth, not everyone is going to want to enroll in the PAYE plan. While this program might sound like a miracle cure, you’re going to have to do some math to decide whether or not it’s actually right for you.
For some borrowers, PAYE will only exacerbate their financial distress, stretching out their student loan payments for years, adding interest to the debt, and making it even harder to get out from under.
But for other borrowers, PAYE will provide significant financial relief, allowing decreased monthly payments, some breathing room to save up cash, and the opportunity to do things like start a family, launch a business, or purchase a home.
Here’s a breakdown of the major pros and cons to the PAYE repayment plan:
Benefits to the PAYE Plan
There’s a reason that this plan was introduced just after a huge economic meltdown – it was created to offer serious financial assistance to people who are struggling to make ends meet.
And PAYE lives up to to the expectations, at least for certain situations, as it offers some serious benefits, including:
Payments are Based on Earnings
While this is nothing new (the Income-Based Repayment Plan and the Income-Contingent Repayment Plan already set monthly payments based on earnings), the PAYE plan offers a significant reduction in the monthly maximum cap.
With IBR and ICR, you could have been forced to pay up to 15% of your discretionary income each month, while with PAYE, you’ll only need to pay a maximum of 10%. Don’t think 5% makes a big difference? Do the math and think again.
Subsidized Loans Won’t Accumulate Interest
One of the big concerns with PAYE is that your monthly payments could end up being so small that they wouldn’t even cover monthly interest accrual, leading to interest capitalization. Interest capitalization means that the unpaid interest is tacked onto the principle of the loan, making your loan more expensive in the long-run, and your monthly payments higher in the short-run.
Fortunately, the PAYE plan includes a provision that protects those of you with certain types of Federal student loans from interest capitalization, because the Government will have to pay your unpaid interest on Direct Subsidized Loans (or on the subsidized portion of your Direct Consolidation Loans) for up to three consecutive years from the date you begin making payments under PAYE.
Interest Capitalization is Limited
Limits on interest capitalization – Should you run past that three year protection, as long as you’ve got a “partial financial hardship” (defined below), your accrued unpaid interest won’t be capitalized, even if it accrues during deferment or forbearance.
Unpaid interest will only capitalized under PAYE if you don’t have a partial financial hardship, and the amount of interest that capitalizes is limited to just 10% of your original principal balance, calculated from the time that you began making payments under PAYE.
Loan Forgiveness Comes at 20 Years
If you use the PAYE plan and meet other certain requirements, whatever is left of your original student loan balance will be forgiven after you’ve made 20 years’ worth (240) of scheduled, full, and on-time monthly payments.
Unfortunately, the only way that there could be anything left after you’ve made 20 years of payments is if you’ve missed payments, had problems that lead to capitalization, or encountered other issues that caused your debt to increase, since the PAYE plan is supposed to have you set to finish making payments at 20 years anyway.
Loan Forgiveness Can Come at 10 Years
This the best way to leverage the PAYE plan, but its also restricted to those individuals who qualify as “public service” workers. Those on the PAYE plan who work full-time for a public service organization (basically any government or non-profit job) will receive complete loan forgiveness after making just 10 years’ worth (120) of scheduled, full, and on-time monthly payments.
This is a huge benefit to those who can qualify, since it dramatically speeds up the prospect of paying off student loan debt early. This program is an enhancement to the traditional Public Service Loan Forgiveness Program, which worked under any of the other available student loan repayment plans, but didn’t offer loan forgiveness until 20 years of payments had been made.
Downsides to the PAYE Plan
Even with all the advantages listed above, there are some issues with PAYE that can lead to increasing the amount of money you spend on student loans, especially in the long-run.
Here are the disadvantages to enrolling in the Pay As You Earn student loan repayment plan:
Long-term, PAYE Will Probably Cost More
While your monthly payments get reduced under PAYE, making it more affordable in the short-run, you’re going to end up paying your loan off over the long-run since reducing monthly payments stretches out the loan’s term, allowing more interest to accumulate over time.
For some people, this isn’t as much of a problem, since the overwhelming reason for signing up is to reduce monthly payments to get them into an affordable range, but if you aren’t having trouble making monthly payments, then PAYE will end up costing you money.
You Must Submit Annual Documentation
The PAYE plan isn’t run on the “honor system”. To qualify for the plan, you’ll have to submit paperwork to prove how much you’ve made each year, and failing to do so will lead to your unpaid interest being capitalized (dramatically increasing the life-time cost of your loan), or even resulting in you being booted from the program.
If you’re good at keeping track of your income or you’ve got a long-term salaried type position then this shouldn’t be a problem, but it could become a nightmare for those of you who are unreliably employed, working for commission or earning unstable types of income.
You Need a Partial Financial Hardship
You’ll only be eligible for the PAYE plan if you’re facing a partial financial hardship (explained below). The good news about this piece is that you’ll get to count FEEL Program loans when determining how much you owe, but the bad news is that only your Direct Loans are eligible for PAYE.
Depending on your unique situation, this could result in the possibility of you having to make monthly student loan payments under multiple repayment plans. It’s always easier to have all your loans on the same plan, just for the sake of logistical clarity, but you may not be able to do that in this case.
You Might Owe Taxes on Forgiven Debt
This is still up in the air, since President Obama has submitted a proposal to erase the tax liability for forgiven debt, but as the law stands now, those who have debt forgiven still end up owing taxes on whatever amount gets forgiven.
That may not seem like a big deal, but because the forgiven debt has to be reported as annual income in your IRS filings, that could dramatically increase the amount of tax money you owe during the year you wipe out your debt, causing you to face a massive, one-time tax bill.
For some people, that may be an even worse financial situation than facing years of low monthly payments. For now, be prepared to put aside some money toward your eventual forgiveness, and don’t assume that this issue will be disappear, because there’s no guarantee that it will go away.
How Do I Apply for PAYE?
First, contact whoever services your loan to ask if you qualify for the program (even if you think you do, or don’t, you might be wrong).
Once you’re sure that you’re eligible to enroll, head on over to the Government’s official student loans website (www.StudentLoans.gov), sign in, and complete their electronic request to enroll in the Income-Based (IBR) / Pay As You Earn / Income-Contingent (ICR) repayment plan.
Proposed Changes to PAYE
Unfortunately, 2014 saw the introduction of some new proposals from President Obama’s Administration which would massively change the way that PAYE and Federal student loan forgiveness works.
These proposed updates including major benefits, but also significant downsides. Depending on your specific financial situation, the adoption of proposed changes could be an awesome cause for celebration, or a disastrous reason for despair.
It’s not all bad. There’s some significant benefits to the proposed changes introduced in the President’s Proposed 2015 Fiscal Budget, including:
It’s Coming to Everyone!
Pay As You Earn will be made available to everyone with Federal student loan debt. This change is already virtually guaranteed to occur, and is set to take place in December, 2015.
Tax Penalties May Disappear
Current law stipulates that qualifying for Federal loan forgiveness allows you to wipe out your debt, but also forces you to pay taxes on whatever debt was removed (because that debt has to be reported to the IRS as “income”).
This can present a major problem for those who really need some financial assistance, and it would be an excellent update to Federal benefits if the tax penalty part were removed from the equation.
Monthly Interest Accrual May Get Capped
The monthly interest accrual on Federal student loan debt may be getting capped at just 50%.
Currently, when you make a monthly payment that isn’t high enough to cover your interest accrual, whatever amount of interest that isn’t being paid gets added to the principal balance of your loan (through the process of interest capitalization), making you owe more money in the long run.
Right now, there’s no cap on the amount of interest that can accrue, which dramatically inflates the loan debt of people who aren’t paying enough to cover their debt’s interest accumulation!
On the other hand, there are some serious potential downsides that may arise from changes to Federal law, some of which could stand to cost you tens of thousands of dollars, including:
Big Debts May Not Qualify
High debt borrowers (those with over $57,000 in federal student loans) won’t qualify for forgiveness under PAYE at the 20 year mark, but will instead have to keep paying back their loans for a full 25 years.
5 years may not sound like much, but that’s another 5 years of potentially not being able to start a family, purchase a home, found a business, or do other things that student loan debt is preventing.
PSLF May Get Capped
Public Loan Service Forgiveness will be capped at $57,000, meaning that borrowers who owe more than that amount won’t be able to get the rest of it written off at the 10 year mark, and will instead need to continue making payments to the full 25 year limit before they can wipe out the remaining debt.
This would significantly reduce the effectiveness of Federal loan forgiveness for those with extreme debt (the people who need assistance the most!).
Only IBR Payments May Count
Only payments made under one of the Income-Based Plans (PAYE, IBR, ICR, etc.) will count toward PSLF loan forgiveness, meaning that it won’t be possible to be on the Standard Repayment Plan, Graduated Repayment Plan, etc., and count those monthly payments towards PSLF’s required 120 monthly payments (10 years’ worth of payments).
This update is no big deal for those people who don’t earn much, but it poses a major financial setback for people with high incomes.
Filing Income Separately May Not Help
Married borrowers will no longer be able to separate their incomes when determining monthly payments under the income-based repayment plans. Currently, couples who file their taxes separately can leave out their partners income when determining how much they need to pay on their monthly Federal student loan payments, sometimes significantly reducing their monthly payments.
Some couples are able to continue earning huge incomes without having to pay much on their student loans, all while working toward that eventual loan forgiveness.
When Will These Changes Go Live?
These proposed changes were included in President Obama’s proposed 2015 fiscal budget, but the good (or bad news, depending on your unique situation) is that they weren’t mentioned at all in the eventual CROMNIBUS that got signed into law.
What’s that mean? For a time, none of these changes are going into place, but since the Higher Education Reauthorization talks are set to commence this year, 2015 is likely to see some major changes to the rules regarding Federal student loan debt.
Be sure to check back often for updates, as I’ll be following developments closely and reporting all changes in real time.
If you have any questions about the Pay As You Earn Plan, please feel free to ask them in the comments section below.
We’ll do our best to get you a response within 48 hours.
And if you don’t qualify for the plan, but need help with your Federal student loan debt, then be sure to check out our pages on Federal Student Loan Forgiveness, Federal Student Loan Deferments and Federal Student Loan Forbearance.
You’re virtually guaranteed to qualify for some form of assistance from one of the above mentioned programs, so don’t give up yet!
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