Why Everyone* Should be on the Pay As You Earn (PAYE) Repayment Plan

Michael Lux Blog, Student Loans 16 Comments

The Pay As You Earn Repayment Plan, better known as PAYE, is the newest and for most, the best Federal Government student loan repayment plan.  It won’t help with your private loans, but if you have any federal government student loans, it could be very helpful.  If you are accustomed to the Income Based Repayment Plan (IBR), then the way the PAYE plan works will be very familiar.  It is just like the IBR plan except the payments are lower and you can get student loan forgiveness sooner.

The Basics

  • Monthly payments on the PAYE plan are limited to just 10% of your discretionary income.
  • After making 20 years worth of payments, the remainder of your student loan debt is forgiven.

For those who are unemployed or underemployed, your monthly payments could be $0.00…  It doesn’t get much better than that.  Not only would you not be spending a dime on your student loans, but each month your are on the PAYE paying zero dollars, you are one month closer to student loan forgiveness.

If you are wondering what the term discretionary income means, it is the money you make in excess of 150% of the federally defined poverty level.  To calculate: your monthly payment =’s (your income – 1.5*Poverty Level) x .1  If this calculation gives a negative number, don’t expect a check in the mail.  It just means your monthly payment will be zero.  If you would be interested in a calculator to show you exactly what your PAYE monthly payments would be, let me know in the comments and I will create one.

The Advantages

PAYE has every feature of IBR, but is better in every way.  The required percentage of your income is lower, and the number of years required for forgiveness is lower.

Even if you plan on paying off your loans sooner (like in 10 years), signing up gives you flexibility for the difficult months.  There is no prepayment penalty.  Suppose you are on the 10 year repayment plan.  If one random month finds you putting a deposit down on a new apartment, fixing your car, and paying for movers, you may not be able to afford your student loan bill for that month.  If you were enrolled in the PAYE, you could just make the minimum payment for the difficult month.  After that you could go back to making payments that would pay off the loan in 10 years.  PAYE is flexible like that.

The interest rates are exactly the same for PAYE as for other repayment plans.  Some people think they will get a lower rate by being on an accelerated repayment plan.  Unlike auto loans and mortgages, the length of the loan has nothing to do with the interest rate.

If your minimum monthly payment is less than the monthly interest, the interest on the loan will continue to accrue, but it will not capitalize.  In basic English, this means you will pay interest, but you will not have to pay interest on the interest.  Therefore, you still should pay off as much as possible when you can.  However, if you can’t pay the full amount of the monthly interest, it won’t hurt you as bad as other repayment plans.

The Bad News

Clever readers may have noticed the glaring asterisk (*) in the title behind the word everyone.  Sadly, not everyone will be able to sign up for this awesome program.  The biggest hurdle is the fact that you can not have any federal loans from before October 2007.  Thus, only recent grads will benefit from this plan.  Many, including this author, are stuck with the IBR and can only look enviously upon those lucky enough to qualify for PAYE.

The other requirement is partial financial hardship.  Your lender will look at two numbers when making this determination.  The first one will be your monthly payments under the 10-year repayment plan.  The other will be 10% of your discretionary income.  If the 10-year repayment plan costs more than the 10% of your discretionary income, you are in.  If it is actually less, don’t feel bad.  It just means you make plenty of money compared to what you owe on student loans.

Finally, the one person who should not sign up for PAYE would be Mr. Minimum Payments Guy.  If you make the minimum payments on your credit card, mortgage, car payment, and student loans even though you don’t have to, avoid this plan.  If you need to force yourself to make larger payments to get your loans paid off ahead of time, this is not the plan for you.

How to Sign Up for PAYE?

  1. Contact your lender as soon as possible.  With IBR and PAYE growing in popularity, the processing times for these programs has grown longer.
  2. Complete the paperwork provided by your lender.  It will be a short form.  In addition to the form you will also have to submit documentation of your income.
  3. Submit either your tax return or two most recent pay stubs.  This is how your income will be calculated.  Be smart with the approach you use.  Think about your personal situation and which method of calculation will likely end up with a bigger payment.
  4. Wait patiently.  Processing this information can take months.  If it is impossible to make payments on your current plan and you are waiting for processing, you can ask for an “administrative forbearance”.  Such a forbearance is not ideal as interest will grow, but its better than missing a payment.
  5. Submit you paperwork each year.  Every year your income will have to be recalculated.  Due to the slow processing times, its recommended you do this months ahead of time.

For further information about this repayment plan:

The Official Department of Education PAYE Fact Sheet

For a comparison of this repayment plan to the other federal repayment plans:

The Sherpa Guide to Federal Repayment Plans