(Updated Fall, 2017)
What is PAYE and How Does it Work?
The Pay As You Earn Federal Student Loan Repayment Plan is what most people are referring to when they talk about “President Obama’s Student Loan Forgiveness Program”.
The reality is that there is no such thing as “Obama Loan Forgiveness”, but that President Obama’s student loan reforms introduced changes to the way loans are handled, including the introduction of the PAYE student loan repayment plan.
And while PAYE was first only available to very few borrowers, PAYE was later expanded with relaxed eligibility guidelines to allow over 5,000,000 (5 million) more Americans to enroll in the plan.
More recently, everyone with loans originating from before 2007 can finally partake in the PAYE benefits too, as they’re now eligible to enroll in PAYE’s sister repayment plan, called the “Revised Federal Student Loan Repayment Plan”, or “REPAYE”.
What PAYE and REPAYE do is they set your monthly student loan payments at a specific percentage of your discretionary income, making it easier to qualify for low payments, as well as promising that your loans will be entirely forgiven after you’ve made 240 on-time, and in full payments (meaning 20 years worth of payments).
This page explains all the fine details regarding what PAYE is, how it works, and how to decide if it’s the right plan for you.
But Before We Dive Into Those Details…
Let me fill you in on a little secret: the fastest, easiest way to get rid of your student loans without paying for them out of pocket is to hire an expert who can help you consolidate them, reorganize them, refinance them, modify them, or challenge their legal validity.
In fact, the single best way to get rid of your loans is to use the Borrower’s Defense Against Repayment Program to try and get a discharge, which wipes them clean, and allows you to walk away without having to pay another penny toward your outstanding loan balance.
But to file a successful Borrower’s Defense Against Repayment Application, or to qualify for other complicated benefits like Bankruptcy Discharges, Closed School Loan Discharges, Loan Forgiveness Benefits, and more, you’ll want to pay an expert to help you figure out which program will work best for you, and ensure that you do everything correctly so you can actually receive the promised benefit.
That’s where the Student Loan Relief Helpline comes in – they’re my favorite student loan debt relief agency because they’re staffed with actual experts who will review your case, give you advice, and offer to handle everything for you (for a fee, of course).
Anyone who isn’t great at reading and understanding complicated legal language would do well to enlist the Helpline’s assistance, as they’ll dramatically increase the odds that your benefits applications are approved.
Your first call to the Helpline is free, so the only thing you’ve got to lose is a few minutes of your time.
Call the Student Loan Relief Helpline now at: 1-833-600-0101.
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.
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)
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 PAYE 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.
However, if you don’t qualify for PAYE because your loan is too old, don’t give up, because it’s highly likely that you’ll still qualify for it’s sister plan, REPAYE, which offers the same benefits.
Also, keep in mind that the required qualifications don’t stop at the type and age of your loan, 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 PAYE.
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
While President Obama has submitted a proposal to erase the tax liability for forgiven debt, that was rejected and the current Student Loan Forgiveness and Income Taxability Laws state that anyone who has debt forgiven will end up having to count whatever amount of debt was forgiven as taxable income, and pay the IRS accordingly.
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.
In fact, for some people, that may be an even worse financial situation than facing years of low monthly payments, and personally, I think we’re headed toward what I’m calling the Coming Student Loan Taxpocalypse, which will hit when everyone’s loans start getting forgiven, and they end up owing tons of money to the IRS.
I think this is such a problem that I’ve created an entirely new website to help people deal with their new tax liabilities, called Forget Tax Debt, which goes through all the same sorts of topics I cover here, but for tax-related issues instead.
Whether you’re looking for help with Filing and Paying Back Taxes, Applying to the IRS’s Fresh Start Program, or Negotiating a Settlement on your Tax Debt, Forget Tax Debt can help, so be sure to visit it for all IRS-related questions.
How Can I Maximize PAYE Benefits?
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.
One thing to keep in mind is that the Public Service Loan Forgiveness Program is available to all sorts of people, because it exists for more than traditional “Public Service” fields, offering benefits like Nursing Student Loan Forgiveness, Military Student Loan Forgiveness, Teacher Student Loan Forgiveness, Non-Profit Student Loan Forgiveness, Government Employee Student Loan Forgiveness, and more!
Also, keep in mind that because PAYE is income-based, it’s possible that you could even qualify for complete Federal Student Loan Forgiveness after 10 years of issuing payments, even if your payments were set at $0 per month during that entire time period! You could literally get your loans entirely forgiven without paying a penny!
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.
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.
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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