With student loan balances averaging more than $29,000 for recent grads and unemployment and underemployment continuing to plague many, some find that their loan payments are unmanageable. The good news is that two newer repayment plan options – Income Based Repayment and Pay As You Earn – are making life oh-so-much better for cash-strapped borrowers.
If you can afford to pay your loans off under the standard 10 year plan (or faster), that’s the financially savvy course to pursue, but if your money is tight, getting into IBR or PAYE can keep you in good standing until you regain your financial footing. But the plans aren’t the same and you may qualify for one or the other or neither. Here’s what you need to know about IBR vs PAYE.
PAYE offers 5% lower payments compared to IBR
To get into either PAYE or IBR, you need to demonstrate at least a partial financial hardship. If you qualify, the next factor is determining discretionary income. This is defined as the difference between your income and 150% of the poverty line for your family size.
Payments under IBR are set at 15% of your discretionary income while under PAYE, they are just 10%. If you file taxes individually or married filing separate, only your income will count. If you file jointly, both incomes will count, but if you both have student loans, that will also be taken into account.
The math: Say you have a family of two, are the sole breadwinner and are making $40,000. You deduct $23,265 (150% of the poverty line) and that makes your discretionary income $16,735. Your annual payments would be $2,510 ($209 per month) under IBR and $1,673 ($139) under PAYE. (see poverty chart below for more info)
Loan forgiveness comes earlier with PAYE compared to IBR
Many borrowers find they can’t afford their student loans, either because they are underemployed, unemployed or have opted for a lower earning career path. If you have a high loan balance and modest earnings, the lower payments IBR and PAYE offer can prolong the repayment period.
In some cases, IBR and PAYE payments may not even cover the cost of interest on the loans, so the balance will never drop and may, in fact, continue to climb. With either, you will qualify for taxable loan forgiveness if you keep up your payments. IBR forgives balances at 25 years and PAYE at 20.
The math: In the scenario above, if you owe a significant balance – say $60,000 – with IBR, you’ll be paid off in exactly 20 years with no loan forgiveness. With PAYE, because of the lower payments, you’ll have about $40,000 forgiven, which can result in a tax burden of $6,000 or more. (see chart below for details on repayment options for this scenario)
Certain loans are ineligible under PAYE but not IBR
More people are eligible under Income Based Repayment than Pay As You Earn. Here’s a quick summary of the eligibility differences between the two programs:
IBR: Direct subsidized and unsubsidized loans, PLUS loans made to students, direct consolidation loans with no parental PLUS loans involved, Stafford loans and FFEL loans and consolidation loans (as long as they weren’t made to parents) are all eligible for Income Based Repayment. Loans that are not eligible for IBR include PLUS loans to parents, consolidation loans that include loans to parents and private loans.
PAYE: Direct subsidized and unsubsidized loans, PLUS loans made to students, direct consolidation loans with no parental PLUS loans involved and Stafford loans are all eligible for Pay As You Earn. FFEL loans are not eligible, neither are PLUS loans to parents, consolidation loans that include loans to parents and private loans. An additional caveat is that you must be a new borrower as of October 1, 2007, had no existing student loan balance as of 10/1/2007 and have had a direct loan disbursement on or after October 1, 2011.
To find out more about IBR and PAYE, check out our Student Loan Help Center for information and How To guides for applying for these repayment plans. And no matter what type of loans you have or your financial circumstances, sign up for Tuition.io’s free student loan tool to manage and optimize your debt, keep track of your payments and see the impact of different repayment plans or making additional payments.