Is Pay as You Earn for You?
June 5, 2013

As of December last year, a new option for cash-strapped student loan borrowers came online called Pay as You Earn (PAYE). It was designed specifically for those in financial hardship and, with the recession leaving debtors increasingly unemployed or underemployed, could help millions of borrowers. This repayment option can slash your monthly payments even lower than either Income Based Repayment (IBR) or the Income Contingent Repayment (ICR) plans.

The PAYE option cuts your monthly payments down to 10% of your monthly discretionary income. This is determined based on your family size and the difference between your income and 150% of the poverty line in your state. Your required payments will be adjusted annually based on any changes to your income. While this sounds good, you may wonder if PAYE is for you? Here are the considerations:

Type of Loans

Not every loan is eligible for PAYE. But if you have unsubsidized or subsidized direct loans, direct PLUS loans made to students and direct consolidation loans, you may qualify. No loans to parents are eligible for PAYE. Loans must be made on or after 10/1/2007 to borrowers who had no prior balances and who took out one or more loans after 10/1/2011. 

Standard Monthly Payment Amount

If your payments under the standard 10 year repayment plan are higher than they would be under PAYE, you are considered a “financial hardship” candidate and can take advantage of the plan as long as you meet the other requirements such as loan type and dates debt was incurred.

Interest Capitalization Savings

Depending on your loan balance, the amount of your PAYE payments may not cover all of your interest. If under the interest on your loan is $300 per month but the PAYE payment is set at $150 per month, you are not servicing the interest on your debt meaning that the unpaid interest would normally capitalize. Under PAYE, for the first three years, the government will cover any unpaid interest. And further, as long as you qualify for PAYE, interest capitalization will be limited.

Forgiveness of Balance

Previously, loan forgiveness kicked in at 25 years, but under PAYE, unpaid balances at the end of 20 years are forgiven. If you qualify for a Public Service Loan Forgiveness program, the forgiveness window opens at 10 years. 

Potential Downsides

This all sounds great, right? Paying less for student loan debt is certainly a boon, but there are some downsides including having to complete the reevaluation paperwork annually. Also you have to consider your prospects for future earnings. Tackling your loans within 10 years is the best way to avoid excessive interest. Otherwise you may have to consider moves like Jagger who is still working hard and touring with the Stones well into his retirement years – albeit probably not to pay off his student loans…

Know that if you are struggling to find a job and jump into PAYE, your interest will pile up – if you stay at a moderate income level until you qualify for forgiveness (essentially the bulk of your career) – this is a non-issue. But if your earnings begin to climb, you’ll be left paying higher and higher payments and will end up paying much more interest. If the total amount you would pay under the 10 year plan is the same or less than you would pay over the 20 years until forgiveness, you may want to bite the bullet and try to eke out your standard monthly payments.

Another option is to take on a PAYE or IBR option and then send in as much additional monthly monies as possible, specifying that the additional amount be applied to principal. To see how to do this, check out the list of other recent blogs on repayment plans listed below. And to make sure you have a good grip on exactly what you owe, try Tuition.io’s free student loan tool to manage and optimize your debt!

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