If you recently took out federal student loans but find that you are not making enough income to cover the monthly payments, the new federal Pay as You Earn Repayment Plan (PAYE) could help you. PAYE, which went into effect on December 21, 2012, offers even more affordable payment options than other traditional income-based repayment plans. This article discusses how PAYE works, whether you qualify, and the pros and cons.
What is PAYE?
PAYE is financial hardship program that essentially reduces your monthly student loan payments based on your income. While there are other income-based hardship programs for federal student loans (such as the Income Based or Income Contingent Repayment Plans), PAYE may be able to reduce your payment to a lower eleven than does those programs. (To learn about the other types of income-based plans, see Student Loan Repayment Options.)
Under PAYE, your monthly payments are reduced to 10% of the amount of your discretionary income. Discretionary income is the amount of your income that exceeds 150% of the poverty level in your state, based on your family size. The PAYE program adjusts the amount of your monthly payments annually. This means they may increase or decrease each year based on your discretionary income.
Here are some of the key components to the PAYE program.
Partial Financial Hardship
PAYE is available to qualified borrowers who have a partial financial hardship. A partial financial hardship means that the amount of the monthly payments that you would otherwise have to make for 10 years under your standard repayment plan is more than monthly payments under PAYE.
For the first three years you participate in PAYE, the government will subsidize any interest that is not paid by your adjusted monthly payments. That interest is not capitalized during the time you are in the PAYE plan.
As with other income-based federal student loan repayment plans, the remaining student loan debt will be forgiven at the end of the program. Under PAYE, your student loan will be forgiven after you have been making payments in the plan for 20 years. They can be forgiven in 10 years if you are employed with a qualifying public service organization.
Not every federal student loan can be included. Only the following Direct student loans are eligible for PAYE:
- Direct subsidized and unsubsidized loans
- Direct PLUS Loans (made to students only, not parents), and
- Direct Consolidation Loans, except if they include PLUS loans made to parents.
(Learn about the different types of federal student loans.)
Do You Qualify for PAYE?
PAYE is not available to most borrowers who are already in repayment on their Direct loans. Instead, it is specifically designed to help students or recent college graduates struggling to find sustainable employment in a depressed job market. To qualify for PAYE, you must:
- be a new borrower (with no prior outstanding federal student loan balances) as of October 1, 2007, and
- have received at least one Direct loan disbursement on or after October 1 2011.
To find out if you qualify, and to calculate payments under PAYE, visit the Federal Student Aid website at www.studentaid.ed.gov/repay-loans/understand/plans/pay-as-you-earn
The Pros of the PAYE Program
PAYE may be a good option for you because:
- your payments are based on your earnings, taking into consideration your family size
- payments are usually smaller than other income-based repayment plans
- loans are forgiven sooner than in other income-based repayment plans (for example, loans in an IBR plan are forgiven after 25 years), and
- unpaid interest is partially subsidized by the government.
The Cons of the PAYE Program
PAYE is not perfect. You should consider this option very carefully because:
- you can't use this plan for other non-Direct federal student loans and cannot consolidate the payments (learn about student loan consolidation)
- it will usually take longer to pay off the student loan than in a standard repayment plan, which means that you will be paying more interest overall
- it is not automatically renewable, so you have submit new financial paperwork every year
- you have to diligently make payments on time, each and every month, to qualify for eventual debt forgiveness, and
- if and when the loan is eventually forgiven, you may have to pay taxes on the amount that was forgiven (although the savings from the loan forgiveness may be more beneficial to you than the potential tax obligations).
To learn about other hardship repayment options, see Student Loan Repayment Options.