What You Need to Know About the Pay As You Earn Student Loan Repayment Plan

Want to learn how to make your federal student loan payments more affordable? You might be able to reduce your monthly payment based on your income. Going into an income-driven repayment plan is a big decision and there are many factors to consider. This article will explain one type of income-based repayment plan, help you determine if you’re eligible, and give you some tips for deciding if the plan is right for you.

What is Pay As You Earn (PAYE) plan?

The Pay As You Earn plan, or PAYE plan, is one of several income-driven repayment plans available for federal student loan borrowers. The PAYE plan can only be used for federal student loans offered by the U.S. Department of Education. The PAYE plan and other income-driven plans cannot be used for private student loans. Like all income-driven plans, the PAYE plan looks at the borrower’s income to calculate their monthly payment.

Borrowers requesting the Pay As You Earn plan must submit an application known as the Income-Driven Repayment Plan Request to their loan servicer. This application asks for adjusted gross income, family size, and other details.

Eligible borrowers then receive their new monthly payment amount from their loan servicer. After 20 years of payments, the borrower’s remaining loan balance will be forgiven as long as they have followed the program requirements. It’s important to remember that borrowers who have their remaining balance forgiven will most likely have to pay income tax on the amount forgiven. So, borrowers who choose to use the PAYE plan for 20 years and seek loan forgiveness should save money for paying tax on the amount forgiven.

Borrower’s planning to use the PAYE plan and having their balance forgiven should be careful and follow the program requirements. Small mistakes will make it harder to get the full benefits of the program like loan forgiveness. Interested borrowers should read and double-check the US Department of Education Office of Federal Student Aid’sresources on the PAYE program requirements.

How are monthly payments calculated under the PAYE plan? 

The PAYE monthly payment amount is calculated by taking 10% of the borrower’s discretionary income and dividing it by 12. Discretionary income is a borrower’s annual income minus 150% of the federal poverty guideline for the borrower. If you’re married, your spouse’s income only factors in if you file a joint tax return. 

You’re not eligible for PAYE if your calculated PAYE payments are higher than your payments under the 10-year Standard Repayment Plan. The 10-year Standard Repayment plan sets monthly payments to pay off the entire loan over 10 years regardless of income. It usually sets monthly payments much higher than an income-driven repayment plan would.

Let’s do an example of this calculation for someone who makes $40,000 per year and has a family size of one. The poverty guideline for a one-person household is $12,880. 150% of $12,880 is $19,320. The annual income of $40,000 minus $19,320 equals $20,680, which is this borrower’s discretionary income. Next, we calculate 10% of the discretionary income by taking 10% of $20,680, which is $2,068. Finally, we divide $2,068 by 12 to calculate the monthly payment of $172.33.

The Office of Federal Student Aid’sLoan Simulator is a helpful tool to calculate your monthly payment under the PAYE and other income-driven plans. But it’s always a good idea to do the calculation yourself and make sure that everything adds up correctly.

Every year, borrowers must recertify their PAYE repayment plans even if there haven’t been any changes to income or family size. To recertify, you must submit a new income-driven repayment plan application to your loan servicer, every year. You can also recertify at any time if you have a significant change in income or household size and want to recalculate your payment. Your PAYE monthly payment can increase or decrease based on changes to your income or household size.

Recertifying every year is important for several reasons. If you’re on a PAYE plan and don’t recertify by the annual deadline, your monthly payment will no longer be based on your income. Instead, it will be the amount you would pay under the 10-year Standard Repayment Plan which is usually much higher. Failing to recertify also causes any unpaid interest on your student loans to be capitalized. This means that all unpaid interest is added to the total loan balance. This will increase your student loan balance and the amount of interest that grows over time.

If you fail to recertify on time you should recertify as soon as possible. Even if you’re recertifying late, doing so will put you back on the PAYE plan amount and stop the capitalizing interest.

Borrowers using the PAYE plan must make sure to send their servicer an income-driven repayment plan application every year. It’s helpful to think of recertification as regular financial upkeep, kind of like filing taxes every year.

Am I Eligible for the PAYE plan? 

The PAYE repayment plan has several eligibility requirements. Only certain types of federal student loans are eligible for PAYE plans:

• Direct Subsidized Loans

• Direct Unsubsidized Loans

• Direct PLUS Loans made to graduate or professional students

• Direct Consolidation Loans that did not repay any PLUS loans made to parents

Some types of loans not listed above are only eligible if they are “consolidated.” A list of those loan types can be found on the “PAYE Plan” section of thegovernment’s webpage on income-driven repayment plans. Loan consolidation combines several student loans into a Direct Consolidation Loan, which is just one direct loan with one interest rate. 

Student loan consolidation is a big decision because it can take away benefits that certain loan types offer. For example, Federal Perkins Loans havespecial cancellation benefits that are lost if the Perkins Loan is consolidated. You can learn more about loan consolidation on thegovernment’s loan consolidation webpage.

You can check your account on your loan servicer’s website or call your loan servicer to find out what types of student loans you have. You can also create a free account with the National Student Loan Data System to get detailed information on all of your federal student loans. Your servicer may also be able to help you determine if your loans are eligible for PAYE.

Is the PAYE repayment plan right for me? 

Each student loan repayment plan has its pros and cons. You should explore all repayment options before choosing one. The first step in deciding if PAYE is right for you is to contact your loan servicer to discuss your different income-driven repayment program options. If you don’t know who your loan servicer is, you can call the Federal Student Aid Information Center at (800) 433-3234 to find out. You can also find a list of servicers and their contact information on the Federal Student Aid’swebsite.

Once you’re on the phone with them - make sure you press them on the different programs that are available. Don’t simply let them talk into a forbearance or deferment. While those may sound like the perfect solution if you’re having trouble making your payments, they are never the best option. 

The PAYE repayment plan is often a good choice for borrowers planning on applying forPublic Service Loan Forgiveness, or PSLF. PSLF offers loan forgiveness for federal student loan borrowers who work in a qualifying public service job for 10 years. 

People seeking to use PSLF generally must use an income-based repayment plan to be eligible. Those interested in PSLF should still consider the other income-driven repayment plans like Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR) to see what’s best for them.

Another issue to consider is that only federal student loan debt is eligible for PAYE. Loans refinanced through private lenders are not eligible. Also, loans that are currently in the PAYE program will become ineligible for PAYE if they are refinanced with a private lender.

Keeping up with your student loan payments is very important no matter what payment plan you are on. If you miss one payment your loan becomes delinquent. The loan stays delinquent until you pay off the amount past due or go intodeferment or forbearance. 

After 270 days (nine months) of being delinquent, your loans could eventually go into default. Having loans in default can result inharsh consequences. Here are just a few problems with student loan default:

• Yourwages can be garnished;

• Your credit score will be negatively impacted for years;

• TheIRS can keep your income tax refund to pay off the defaulted loans;

• Your entire student loan balance including interest immediately becomes due in full;

• You cannot go into an income-driven repayment plan;

• You cannot receive any more federal student aid like grants and loans.

If you miss a student loan payment, it is usually best to immediately contact your loan servicer to discuss options like what payment plan is best for you and whether a short deferment or forbearance may be all you need to deal with a short term problem. If you do not know who your loan servicer is, call the FSAIC at (800) 433-3234 to find out.

Let’s Summarize 

Student loans are stressful, complicated, and confusing. But student loan payments don’t always have to force you into financial struggle. Understanding your different repayment options like PAYE and other income-driven repayment plans is a great way to stay on top of your student loans. PAYE and other income-based repayment plans are excellent choices for people who don’t expect to make a large annual income for the foreseeable future and want to minimize their monthly loan payments. 

A pay as you earn repayment plan is not for everyone, however. Borrowers with small loan balances might end up paying more over time under the PAYE plan. Borrowers that have Perkins Loans or loans with other strong benefits should strategize to keep those benefits while reducing payments on less desirable loans.