The Dangers of Switching to REPAYE

Michael Lux Blog, Strategy 13 Comments

4/30/17 Update: Thanks to a couple of sharp readers who noticed an issue with this article, it has been updated.  The previous text that was wrong is now crossed out, with the updated information below.

12/30/19 Update: The article has been modified again to include updated information about the Master Promissory Note and to clarify one section per a reader suggestion.

Revised Pay As You Earn is the latest income-driven repayment plan offered by the federal government. REPAYE was created to help borrowers currently on the Income-Based Repayment Plan. Unfortunately, there are a couple of dangers associated with REPAYE that all borrowers should understand before signing up.

Before we get to the specific dangers, a little history lesson is necessary. The timeline looks like this: IBR was created, and borrowers rejoiced. Monthly student loan payments capped at 15% of your discretionary income. Years later, along comes Pay As You Earn, the plan that works just like IBR, but with a key difference. Instead of paying 15% each month, borrowers only had to pay 10% of their discretionary income. This was great for some borrowers, but for people who took out student loans too long ago, it wasn’t an option. In 2015, President Obama ordered the creation of a new plan to help out the people whose loans are too old for PAYE. Thus, REPAYE came into existence.

While REPAYE does help out many people who missed out on PAYE, it is far from a perfect solution. In fact, it may be a mistake in some circumstances.

Here are three ways REPAYE could be a mistake:

Issue 1: You are married, and your spouse does not have federal student loans.

IBR and PAYE have a pretty simple mechanism in place to avoid a “marriage penalty” for student loan borrowers. If you want your payments to be calculated independently from your spouse’s income, you file your taxes separately. It isn’t a perfect system, but it can shield spousal income from student loan payments.

REPAYE has no such provision. Whether you and your spouse file taxes separately or jointly, spousal income is still expected to be reported. The question then becomes, which is better, 10% of your combined income or 15% of your individual income? The differences in the tax bill only serve to complicate the math further.

The bottom line here is that if you are married and your spouse does not have federal student loans, you will have some serious math to do to find out your best option.

Issue 2: You have been on IBR for a long time and are closing in on forgiveness.

One of the nice parts about IBR is that if you make the required payments for 25 years, the remainder of your loan balance is forgiven. (Note: it is still taxed by the federal government, but the student loan is forgiven).

REPAYE is very similar, and in some ways better.  If you have undergraduate loans, they can be forgiven after 20 years. If you have graduate school loans as well, they can be forgiven after 25 years.

The problem is that these are two separate clocks. Suppose you have made IBR payments for 7 years and are thinking about having them forgiven in the future. Does it make sense to get lower payments on REPAYE and start the clock over? Or do you stick with the higher payments in order to keep your progress? The best plan will again come down to the math. The tricky part is that nobody knows there future earnings. As a result, it is a smart move to map out how these things work out at a number of different salaries.

The previous paragraph has been struck because switching from IBR to REPAYE should not affect any forgiveness clock. For those interested, the Code of Federal Regulations § 685.209(c)(5)(v) specifies that prior payments under IBR and other income-driven repayment plans will still count towards forgiveness under REPAYE. However, many loan servicer representatives are improperly trained on this particular issue. It led to the inaccurate information that originally appeared in this article, and even though the law is clear on this question, there is a real possibility that loan servicers could handle this math wrong.

Hopefully, loan servicers will get things correct by the time individuals are eligible for forgiveness under REPAYE. Still, all borrowers would be wise to carefully track and record all of their payments should the loan servicers not be giving proper credit for prior IBR payments.

However, it should be mentioned that this issue does not apply to Public Service Student Loan Forgiveness. With PSLF, it does not matter which repayment plan you are on, as long as it is a PSLF eligible plan such as IBR or REPAYE.

Issue 3: REPAYE was created by executive order.

During the 2016 election, President Obama’s use of the executive order has been a frequent source of discussion. One way in which he issued an executive order was in the creation of the Revised Pay As You Earn Plan. Because a stroke of the President’s pen created REPAYE, a stroke of the President’s pen can also eliminate it.

This aspect of REPAYE is much different than IBR. Unlike REPAYE, IBR was passed into law by an act of Congress and signed by the President. Thus, if a new President wanted to eliminate REPAYE immediately, it could be done. However, a plan like IBR would take help in the form of an act of Congress if the President wanted to get rid of it. As a result, IBR should be seen as a more stable plan.

Borrowers concerned about the possible elimination of REPAYE via executive order do have a couple of reasons for comfort:

  1. President Trump has not taken any steps to eliminate REPAYE. Secretary of Education Betsy DeVos has a long track record of collecting as much debt as possible from borrowers, but this move hasn’t even been publicly discussed.
  2. REPAYE is written into the Master Promissory Note (MPN). The MPN is a document that all federal student loan borrowers are required to sign. It is the contract between the government and the borrower. REPAYE is now a term of the MPN. Eliminating the REPAYE plan could violate this contract for certain borrowers.

Thus, even though REPAYE was created by executive order and is less set in stone than the other repayment plans, there are some protections in place for borrowers.

So when is REPAYE a mistake?

If you are married or working towards student loan forgiveness, signing up for Revised Pay As You Earn could be a mistake.  Do some research, run the numbers, and call your loan servicer.  A wrong decision here could be an expensive mistake.

Borrowers interested in doing the math on the various repayment options should visit the Department of Education’s Student Loan Repayment Estimator. This tool should help find opportunities for savings and identify circumstances where signing up for REPAYE could be expensive.