What is The Pay As You Earn Student Loan Repayment Plan (PAYE)?
In 2019, the Pay As You Earn Federal Student Loan Repayment Plan (“PAYE”) remains the most powerful, most affordable of all the Federal Student Loan Repayment Plans on offer.
Why? Because PAYE sets your monthly student loan payments for Federal loans at just 10% of your discretionary income.
Ill explain exactly what discretionary income means in just a moment, but for now, let’s put that 10% number in perspective by comparing PAYE’s monthly payment cap to each of the other Income-Driven Federal Student Loan Repayment Plans:
|Payment Plan||Monthly Payment|
|Pay As You Earn (PAYE)||10% of Discretionary Income|
|Revised Pay As You Earn (REPAYE)||10% of Discretionary Income|
|Income-Based Repayment (IBR)||15% of Discretionary Income|
|Income-Contingent Repayment (ICR)||20% of Discretionary Income|
With this knowledge in mind, if you have Federal student loan debt, and your goal is to pay as little money as possible each month, then you should first look at PAYE (or REPAYE), because those will be your best options.
Now that I’ve got your attention, let’s go through all the details about what PAYE is, where it came from, how discretionary income (and thus monthly payments) are calculated, and how to decide whether or not PAYE is the right plan for you!
But Before We Dive Into Those Details…
Let me fill you in on the dirt little secret of student loans: the fastest, easiest way to get rid of your debt is to pay an expert to review your case and tell you exactly what strategy would work best.
Why would I advise paying someone for help when so many articles say that you should do it all yourself? Because I’ve been helping people deal with their student loans for 10 years, and the people with the best outcomes have been those who paid an expert to create their repayment strategy for them.
But there’s only one company I trust to advise my readers: the Student Loan Relief Helpline. The Helpline is staffed by actual student loan experts who will review your case and provide specific instructions on what you should do, whether that’s to consolidate, refinance, or pursue some sort of discharge or forgiveness benefit.
The Helpline only charges a few hundred dollars for their advice, and it could save you thousands or even tens of thousands of dollars over the lifespan of your loans.
To get your students in order, call the Student Loan Relief Helpline now at: 1-888-906-3065.
How Do the Income-Driven Student Loan Repayment Plans Work?
All of the Income-Driven Repayment Plans work in similar fashion, by setting your monthly payments at an amount based on your income and family size.
Typically, these plans significantly reduce your monthly payment amounts when compared to the Standard Repayment Plan.
Here are some other things that all of the IDR plans have in common:
- All IDR-plans offer loan forgiveness at some point (PAYE and REPAYE at 20 years, IBR and ICR at 25 years)
- All IDR-plans require you to pay income taxes the debt you have forgiven (unless you qualify for PSLF or some other similar Federal Loan Forgiveness Program)
- All IDR-plans require that you certify your income and family size each year
- All IDR-plans should save money in the short-run by reducing monthly payments, but at the same time, they increase the total cost over the lifespan of your loans
With that out of the way, why would you choose PAYE over the other IDR plans?
Why Would I Want to Use PAYE?
Simply put, PAYE is the cheapest loan repayment plan available for Federal student loans.
PAYE sets a an arbitrary cap on your monthly student loan payments, forcing your servicing company to charge no more than 10% of your discretionary income.
And because your payments are capped based on income, that means that PAYE can (and usually will!) dramatically reduce your monthly student loan payments, especially if you don’t make much money, or if you have a big family.
I’ll explain how that works in just a minute, but for now, allow me to introduce the two best reasons to consider using PAYE for your Federal student debt:
- PAYE offers the earliest loan forgiveness of any plan (total forgiveness at 20 years)
- PAYE offers the lowest monthly payments of any plan (capped at just 10% of discretionary income)
If you’re having trouble making your monthly Federal student loan payments, then PAYE should be the first place you look for financial relief.
With that said, let’s talk abut how PAYE actually works, and what makes it such a great option.
How Does PAYE Work?
First, PAYE requires that you certify your income and family size each year by submitting IRS details to the Department of Education via your Student Loan Servicing Company, as this is the information they use to calculate your discretionary income, which will be used to set your monthly payment rates.
This process means that your payments could change year to year, but they’ll at least remain consistent between the certification periods, an the nice part about this is that it means your payments will fluctuate based on how much you make, giving you some breathing room if you end up unemployed or getting underpaid.
PAYE is a much more forgiving way to pay off your loans compared to being told that you must pay some certain amount each month, no matter what you make, so it’s especially attractive to people who have unstable incomes, or low incomes.
Also, one important thing to note about PAYE is that the maximum monthly payment is capped not just at 10% of your discretionary income, but also at whatever you’d be forced to pay under the Standard Repayment Plan on a 10 year repayment term, so there is no chance that you could end up paying MORE under PAYE than you pay under the Standard Repayment Plan.
Finally, PAYE offers complete student loan forgiveness after you’ve made 240 monthly payments on time, and in full. That means that you’ll have to pay whatever PAYE sets your payments at for 20 years, but even if you still owe a ton of money at that point, the debt will be forgiven.
How are PAYE’s Monthly Payments Calculated?
Once you’re enrolled in the Pay As You Earn student loan repayment program, your monthly payments will be calculated according to a mathematical formula based on two factors:
- Your Discretionary Income (higher incomes pay more, lower incomes pay less)
- Your Family Size (based on the number of people who live in your household, with larger families getting to pay less each month
Basically, the less money you make and the larger your family is, the lower your monthly payment will be.
To figure out what your payments will be, first you’ll need to calculate your discretionary income.
Discretionary income typically refers to the amount money you have left over after paying for necessities for yourself and your family, so it’s whatever is left over after you’ve paid rent, utilities and food.
But for student loan purposes, discretionary income is calculated more simply, by taking your gross income after taxes and subtracting 150% of the Federal poverty guideline for the size of your family.
Here are the poverty guideline rates for the 48 contiguous States and Washington D.C. this year, based on family size:
|Family Size ("Household Size")||150% of the Poverty Guideline|
Once you’ve calculated your discretionary income using this formula, you can find out what your monthly payment under PAYE will be by multiplying your calculated discretionary income by .1 (.1 = 10%).
To simplify the process and avoid doing the math yourself, try checking out the Government’s official Student Loan Monthly Payment Calculator, which you can find here.
Next let’s find out if you’re even eligible for using PAYE.
How Does PAYE Loan Forgiveness Work?
One of the best parts of the PAYE plan is that you will qualify for complete student loan forgiveness after you’ve made 240 payments under the plan.
These payments have to be made according to PAYE’s official schedule, they have to be for the full amount required by your plan, and they have to be sent in on time, but they don’t have to be consecutive.
That means you will need to make 20 years worth of payments, but that your loan may not be forgiven as soon as you hit the 20 year mark, since you may have missed a payment here or there, or paid too little once or twice.
It also means you can’t issue a whole bunch of payment all at once, but that you have to wait for the payment to be due each month before submitting it, or it won’t count toward the 240 payment threshold.
The most important thing to keep in mind about PAYE loan forgiveness is that you will have to pay the IRS taxes on whatever amount of money gets forgiven, and for details on how that works, make sure to visit my Guide to Student Loan Forgiveness and Taxable Income.
What Loans Are Eligible for PAYE?
Only Direct Loans are eligible for PAYE, which means that anyone with a Federal student loan that is NOT a Direct loan won’t be able to take advantage of this 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, even if you do have a Direct Federal loan, you may still not qualify for PAYE, because it’s only available to “New Borrowers” (defined in very specific terms, which I’ll outline below).
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 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.
This leaves the vast majority of those holding federal student loan debt out of contention for leveraging the Pay As You Earn plan, but the good news is that even if you don’t qualify for PAYE because you aren’t a “New Borrower”, you may still be able to qualify for PAYE’s Sister Plan, the Revised Pay As You Earn Plan (REPAYE).
For details on how REPAYE works, please visit my Guide to the Revised Pay As You Earn Student Loan Repayment Plan.
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, which 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”.
To find out if you’re facing a partial financial hardship, you’ll need to add up the amount of money you owe on eligible student loans (including only Federal Direct loans and FFEL 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. Most people who don’t have a Partial Financial Hardship, but who still want to enroll in an Income-Driven Repayment Plan will need to look at the Income-Contingent Repayment Plan as their last resort.
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.
Again, the easiest way to find out whether or not you qualify for PAYE is to enter your information into the Government’s official online Repayment Estimator.
Pros & Cons of PAYE
To tell you the truth, not everyone is going to want to enroll in the PAYE plan. Why?
Because 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 your best option in both the short-term and the long-run.
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 pay off their loans.
But for other borrowers, PAYE will provide significant financial relief by decreasing the amount of monthly payments, giving them 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 of 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 of 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.
PAYE vs. the Other Income-Driven Plans
As I’ve already outlined above, there’s really one huge advantage to PAYE when comparing it to the other IDR plans, which is:
- PAYE offers the lowest monthly payments of any plan (except REPAYE, which is typically going to set payments at the same amount)
But PAYE isn’t perfect, because it does come with some downsides as well, including:
- Requiring that you have a “partial financial hardship” in order to qualify for the benefit
- Requiring that you meet the conditions of a “New Borrower” to get enrolled on the plan
- Not allowing you to use the plan if you don’t have a Direct Loan
- Ending up costing more than the other IDR plans over the lifespan of your loan
To decide if PAYE is really right for you, you’l have to do the math, and think about what you want to prioritize – lower monthly payments, or a lower total cost of your loan over the lifespan of paying back the debt.
PAYE vs. The Income-Based Repayment Plan (IBR)
For most borrowers, PAYE is going to be a better option than the IBR plan, but again, this depends on your unique financial situation and goals.
You’ll want to use PAYE if your goal is to reduce monthly payments to their lowest possible level, since PAYE sets them at just 10% of discretionary income, while IBR sets them at 15%.
But of course, you’ll only be able to use PAYE if you have a partial financial hardship AND meet the conditions of being a “New Borrower”, whereas IBR doesn’t require you to be a “New Borrower”.
Personally, I would recommend trying to qualify for PAYE first, then only consider using IBR if that doesn’t work out. (For the record, I’d probably try REPAYE before IBR too!).
PAYE vs. The Income-Contingent Repayment Plan (ICR)
In most cases, PAYE is significantly better than ICR because it offers a much lower monthly payment.
While PAYE sets your monthly payments at just 10% of discretionary income, ICR is going to place them at 20% – literally twice as expensive.
Also, PAYE offers earlier loan forgiveness than ICR, giving it at 20 years worth of payments, whereas ICR requires making 25 years of payments, and that 5 year difference can mean a lot of money in total costs.
So why would anyone choose ICR over PAYE? Because ICR is much easier to qualify for. It doesn’t require having a partial financial hardship or being a “New Borrower”, and ICR is also available to people with Parent PLUS Loans, whereas PAYE is NOT.
Finally, if you can afford to pay more than the monthly payments that you’re supposed to make under PAYE and you plan on paying off the full amount of your loan before it’s forgiven at the 20 years mark, then it’s better to do it under ICR since you’ll end up paying less over the lifespan of the loan.
PAYE vs. the Revised Pay As You Earn Repayment Plan (REPAYE)
PAYE and REPAYE are honestly almost identical, except that REPAYE doesn’t require being a “New Borrower”.
If you don’t qualify for PAYE because of the “New Borrower” restriction, then you should look into REPAYE and see if you’ll qualify for it instead.
Other than that eligibility rule, there’s almost no difference between these two plans as each of them set monthly payments at 10% of discretionary income.
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!
Via a combination of PAYE and PSLF, you could literally get your loans entirely forgiven without paying a single 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 consider enrolling in PAYE.
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 qualify for PAYE, your servicer gets final say in who is allowed to use it or not, so be sure to ask them before making any other financial plans or decisions.
Once you’re sure that you’re eligible to enroll, tell your servicer that you want to switch to the PAYE plan, and they will let you know exactly what you need to do to get enrolled.
President Trump & Education Secretary Betsy DeVos HATE PAYE
If you’ve been following student loan-related news, then you’re probably well aware that President Trump and Education Secretary Betsy DeVos are dead-set on ELIMINATING the Pay As You Earn Student Loan Repayment Plan from existence.
No one knows whether or not PAYE will actually be taken away, but President Trump’s Student Loan Reform Plan is clearly looking to get rid of it entirely, along with other important student loan forgiveness benefits, like the Public Service Loan Forgiveness Program, and even the Borrower’s Defense Against Repayment Discharge Program.
For now, there’s no way of telling how this will all shake out, and as long as President Trump remains in office, there’s always a chance that PAYE could be taken away at any time.
Other Student Loan Topics
I made Forget Student Loan Debt to help people figure out How to Get Rid of Student Loans Without Paying for Them, and in the last 10 years, I’ve created over 100 Guides to help explain each part of the student loan repayment process.
If you’re looking for help dealing with your debt, then you’ve certainly come to the right place, because I’ve got all sorts of tips and tricks just like you found in this Guide scattered throughout the rest of my site.
To get Help with Federal Student Loans, visit my Guides on:
- Federal Student Loan Forgiveness
- Federal Student Loan Bankruptcy Discharges
- Federal Student Loan Consolidation
- Federal Student Loan Delinquency & Default
- The Federal Student Loan Rehabilitation Program
- Stopping Federal Student Loan Wage Garnishments
- Federal Student Loan Deferments
- Federal Student Loan Forbearances
- Federal Student Loan Repayment Plans
And for Help with Private Student Loans, look at my Guides on:
- Private Student Loan Forgiveness
- Private Student Loan Consolidation
- Private Student Loan Bankruptcy Discharges
- What to do After Defaulting on Private Student Debt
If you have questions about PAYE, any of the other IDR Repayment Plans, or anything else related to student loans, please do feel free to post them in the Comments section below and I’ll do my best to get you a quick response!
NOTE: Please do not attempt to contact me via email or Facebook, as I will ONLY respond to Comments posted here on FSLD.
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Disclaimer:Information obtained from Forget Student Loan Debt is for educational purposes only. You should consult a licensed financial professional before making any financial decisions. This site receives some compensation through affiliate relationships. This site is not endorsed or affiliated with the U.S. Department of Education.