The Ultimate Guide to the Pay As You Earn (PAYE) Student Loan Repayment Plan

If you want to lower your federal student loan payment, choosing an income-driven repayment (IDR) plan can help. Income-driven plans include various repayment options that are more affordable and based on your income.

One IDR plan option is the Pay As You Earn (PAYE) student loan repayment plan. All of the income-driven plans are a bit different, so in this guide, we’ll cover everything you need to know about PAYE.

What is Pay As You Earn student loan repayment plan?

All IDR plans cap their monthly payments as a specific percentage of borrowers’ discretionary income, including the Pay As You Earn student loan repayment plan.

Under PAYE, your monthly student loan payments are 10 percent of your discretionary income — but not more than what it would be on a Standard Repayment Plan (because if that were the case, then technically you could afford to be on a 10-year Standard Repayment Plan).

Your monthly payment amount may change year to year depending on your income as well as your family size.

Having payments that are 10 percent of your income can make the student loan repayment process more manageable, making PAYE an attractive option. Not only that but after 20 years of repayment, any eligible federal student loan balance you still have is forgiven.

However, with current IRS code, you’ll have to pay taxes on that forgiven amount. While PAYE is a great option, not every borrower qualifies.

Who is eligible for PAYE?

The 10 percent monthly payment makes PAYE a great option for borrowers struggling to make federal student loan payments. But it’s important to see if you qualify for the PAYE program first.

In order to be eligible for PAYE:

• You have to be a new borrower. That means taking on loans on or after October 1, 2007, with a disbursement of a Direct Loan on Oct 1, 2011, or later.
• You must have an eligible loan. Your loans must be Direct Subsidized or Unsubsidized Loans, Direct PLUS loans (for students), or Direct Consolidation Loans (PLUS loans to parents don’t qualify).
• You must have a high debt-to-income ratio to qualify.
• Your loan payments need to be lower than what they would be under a Standard Repayment Plan.

Under PAYE you save money on your monthly payments now, but you end up paying more over the course of your repayment due to the interest that accrues. There’s also the potential tax bill that could hit you after 20 years if there’s a remaining federal loan balance that’s forgiven, too.

If you want to pursue Public Service Loan Forgiveness — which requires you to be on an income-driven plan, PAYE could be a good option for you.

What are the pros and cons of PAYE?

If you’re thinking about choosing PAYE as a repayment plan, consider the pros and cons first. It’s also good to know that if this repayment plan ultimately isn’t a fit, you can change your repayment plan at any time with your loan servicer.

Pros of PAYE:

• Caps monthly payments at 10 percent of discretionary income
• Forgiveness after 20 years
• Good plan for newer borrowers
• If married, your spouse’s income won’t affect your payment unless you file a joint tax return
• There are some subsidies available for accrued interest

Cons of PAYE:

• Not all borrowers all eligible
• You’ll pay more interest
• Potential to be phased out by future administrations
• Pay taxes on forgiven student loan amount

How does PAYE differ from other income-driven plans?

As noted above, PAYE is just one of four income-driven plans that are available to federal student loan borrowers. While they are similar, there are some important differences to be aware of.

The PAYE option differs from the other income-driven plans as only “new borrowers” are eligible for this option. In contrast, programs like PAYE’s cousins, the Saving on a Valuable Education (SAVE) Plan and Income-Contingent Repayment (ICR) Plan are available to all Direct Loan borrowers.

Another important distinction affects married borrowers. Under the PAYE program, your spouse’s income will only be considered if you file a joint tax return. If you file separately, only the primary borrower’s income is considered.

This was not the case for the old REPAYE program, which has now been replaced with the more generous SAVE plan.

When it comes to interest savings, PAYE, SAVE, and Income-Based Repayment (IBR) plans all offer interest subsidies.

So let’s say that your monthly payment doesn’t cover all of the interest that accrues on your loans. In that case, there are subsidies that can help.

The PAYE program, as well as IBR, have subsidies available for up to three years if your monthly payments do not cover all of the interest that accrued. In other words, the government will pay your remaining interest on your subsidized loans for up to three years.

The Federal Student Aid website offers this example:

“For example, if the monthly interest that accrues on your subsidized loans is $40, but your monthly PAYE or IBR plan payment covers only $25 of this amount, the government will pay the remaining $15 for the first three consecutive years from the date you began repaying your loans under the PAYE or IBR plan.”

Your unsubsidized loans aren’t eligible for any subsidies so you must pay the interest for those loans as well as the interest on your subsidized loans after your three-year period is up.

The good news is that although you’ll pay more interest over time with a PAYE plan, the amount won’t be too high. When it comes to paying back loans, your interest can be capitalized.

Capitalization means that your interest is then added to your total principal balance, which then accrues even more interest. So you’re paying interest on interest!

PAYE does not capitalize on most conditions and will only do so under two conditions:
1. You are no longer eligible for the plan.
2. You decide to leave the PAYE plan.

If you no longer are eligible for PAYE, the amount of interest that’s capitalized is capped at 10 percent of your original principal balance when you entered into the PAYE plan.

Deciding to leave the Pay As You Earn repayment plan for something else? The unpaid interest has no limits and can be capitalized, increasing your overall balance.

In comparison, the SAVE plan offers a federal subsidy that covers all of the remaining interest on your subsidized loans. But there is no payment cap, which can become problematic for high-income earners. Additionally, the SAVE plan requires 25 years of repayment to receive taxable loan forgiveness.

Having the 10 percent cap if you no longer qualify is an added perk of the PAYE plan and a differentiator from the SAVE plan.

So while SAVE can be more enticing and financially lucrative with the federal subsidies, having that capitalization limit with PAYE can be helpful if you need it.

How to sign-up for PAYE

Once you’ve decided that Pay As You Earn repayment plan is the right income-driven plan for you, you need to apply. You won’t be automatically enrolled in the program. Talk to your loan servicer first and submit the Income-Driven Repayment Plan application.

You can do that easily on StudentLoans.gov. In fact, the StudentLoans.gov website states that the whole process should take just 10 minutes or less.

When submitting your application, you can choose the PAYE plan or ask your loan servicer which IDR options you may be eligible for that have the lowest payment amount possible.

It’s important to note that if you have more than one loan servicer, you need to repeat this process for all of them. Also, private student loans are ineligible for any IDR plan.

During the application process, you’ll need to submit your income and verification which can determine if you qualify for PAYE. Additionally, your income will be used when determining how much your monthly payment will be.

Once you’ve submitted the relevant paperwork, your loan servicer will process the application which could take up to several weeks to get approved.

Remember, being on an Income-Driven Plan, including PAYE, is not a set it and forget it arrangement. You must recertify each year by updating your income and family size.

It’s important to do this in a timely manner because if you don’t recertify on time your payments will revert back to what they were on a Standard Repayment Plan. However, you’re not required to report changes to your finances until it’s actually time for your annual recertification.

If you’re on an Income-Driven Plan it’s likely because you can’t reasonably afford the Standard Repayment Plan, so this can come to be a financial shock to your system. To add insult to injury, your interest will be capitalized, too.

How will your income be verified?

If you want to pursue PAYE, verifying your income to determine your monthly payment is a part of the process.

To calculate your discretionary income, you’d take 150 percent of the poverty guideline for your state and family size, and subtract that number from your Adjusted Gross Income (AGI).

Here’s an example from the Federal Student Aid website:

• You are single and your family size is one. You live in one of the 48 contiguous states or the District of Columbia. Your AGI is $40,000.
• You have $45,000 in eligible federal student loan debt.
• 150 percent of the 2018 HHS Poverty Guideline amount for a family of one in the 48 contiguous states and the District of Columbia is $18,210. The difference between your AGI and 150 percent of the Poverty Guideline amount is $21,790. This is your discretionary income.
• If you’re repaying under the SAVE Plan, the PAYE Plan, or (if you’re a new borrower) the IBR Plan, the calculation works like this:
  • 10 percent of your discretionary income is $2,179.
  • Dividing this amount by 12 results in a monthly payment of $181.58.

When it comes to proving your income, your AGI is used if you have filed a tax return for the past two years and your income now is still pretty close to that amount.

If that’s the case, the good news is there’s an IRS Data Retrieval tool to make this part easy (phew!).

But what if you haven’t filed a tax return? You’re not totally out of luck, but you’ll need to provide some form of alternate documentation, like a current pay stub, or you must indicate on your application that you currently have no taxable income.

You can use the Repayment Estimator tool or you can use our handy student loan calculator to get a glimpse into what your monthly payments will look like.

And remember, with federal student loans, you can change your repayment plan if you’re not happy with your current option.

Using PAYE to help you afford student loan repayment

The Pay As You Earn student loan repayment plan can be a useful tool for federal student loan borrowers needing a little help. This plan makes payments more manageable and there are undeniable perks with the 10 percent discretionary limit, 10 percent capitalization limit if you no longer qualify, and the tax situation for spouses.

If you need help getting your payments under control and decided PAYE is right for you, contact your loan servicer today.

Have you considered PAYE as an option for repaying your student loan debt? Why or why not?