With the average debt burden for indebted graduates surging over $35,000 in 2015, desperate students are exploring all their options when it comes to loan forgiveness and creative payment options. The Pay As You Earn repayment plan, also known as PAYE, is one option which has received increased scrutiny and popularity ever since President Obama called for an expansion to the program in the summer of 2015.
Like any other loan forgiveness program, PAYE has myriad benefits – and a few drawbacks. Let’s start with the positive. For borrowers who qualify, PAYE caps monthly federal student loan payments at 10 percent of their discretionary income. This detail alone sets PAYE apart from Income Based Repayment (IBR), another repayment program, which caps monthly loan payments at 15 percent of discretionary income. Just like IBR, however, loans involved in the PAYE program will be forgiven in full by the federal government after 20 years.
The biggest drawback you’ll find with PAYE is that you’ll have to make student loan payments for 20 full years. No matter how you look at it, that’s a long time. Further, the elongated timeline may mean you’re mostly paying interest on your loans for the duration of the pay period. This may not matter to you since your loans will be forgiven after 20 years, but it’s something to consider nonetheless.
How to Know When PAYE Makes Sense
Here’s the big question everyone is asking: Will paying on your student loans for a full 20 years really benefit you?
The truth is, it depends.
For students who expect to earn a modest salary for the duration of their careers, PAYE and even IBR can transform crushing student loan payments into something a whole lot more tolerable. Further, students who wound up borrowing far more than they planned might find that PAYE or IBR one of the only options they have if they hope to live a normal life.
Let’s consider an example:
Let’s say Steven borrows $50,000 at 8 percent APR to pursue a Bachelor’s degree in Psychology. After completing his program, he settles into a career as a Community Health worker earning close to the national annual mean wage for this profession – $38,180.
After paying an average of 25 percent of his salary in taxes, Steven is left with $28,635 per year or $2,386.25 per month.
If Steven paid down his loans on the standard ten-year timeline without refinancing, his monthly payment would average $606.64 – or more than 25 percent of his take home pay.
If he qualified for PAYE, on the other hand, Steven’s student loan payments would be limited to 10 percent of his discretionary income, a figure the government describes as the “amount by which your adjusted gross income (AGI) exceeds 150% of the poverty guideline amount for your state of residence and family size.”
In other words, Steven’s monthly payment under PAYE would only be a fraction of what it would normally. Better yet, his entire balance would be forgiven after twenty years of timely payments. That goes even more for someone who had 100k in student loan debt.
One other thing to consider is whether or not you took out federal student loans without cosigner parents. If you have a cosigner you will be hurting their credit if you aren't able to make the payments. That alone could be a reason to make sure Mom and Dad don't get hurt by your loans.
How to Qualify for PAYE
A complex set of requirements obfuscates what it actually takes to qualify for any type of student loan forgiveness, especially PAYE. Here are some basic guidelines that can help you decide if you qualify:
You may qualify for PAYE if:
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- The monthly payment you would make under the PAYE or IBR plan (based on your income and family size) is less than what you would pay under the Standard Repayment Plan with a 10-year repayment period
- Your federal student loan debt is higher than your discretionary income or represents a significant portion of your annual income
- You’re a new borrower as of October 1, 2007, and you have received a disbursement of a Direct Loan on or after October 1, 2011
- You borrowed money in the form of federal student loans.
Pay As You Earn is eligible on the vast majority of federal loans. In fact, the only type of federal loans not eligible for PAYE are Direct PLUS Loans made to parents and Direct Consolidation Loans that repaid PLUS Loans made to parents.
It’s also okay if you’ve already consolidated your loans as long as they weren’t turned over to a private lender. Please note that only federal student loans can be repaid under the income-driven plans. Private student loans are not eligible for any type of loan forgiveness and you may need to look at how to get a loan from a bank to refinance these private loans..
To qualify, your loan must also be in good standing and not in default.
Who Can Benefit from PAYE?
While anyone with plenty of student loan debt may benefit from programs like PAYE or IBR, loan forgiveness isn’t an option that suits everyone. Some people, for example, what to kill all their debts – including student loans – as quickly as possible no matter the cost. Further, other people’s incomes will automatically disqualify them from qualifying for any type of income based repayment.
Still, income-driven repayment options are essential for a large swath of graduates who borrowed a lot of money to pursue careers in low-paying fields. The following checklist can help you determine if PAYE is something you, yourself, should look into:
You may benefit from income-based repayment options like PAYE if:
- You borrowed the full freight of the cost of your education and plan to pursue a low-paying career
- You don’t mind paying monthly payments on your student loans for 20 years.
- Your normal monthly payment (without using PAYE) represents a large portion of your future take-home pay
- You’re struggling to make student loan payments each month
PAYE isn’t a good option if:
- Your monthly income disqualifies you from qualifying for PAYE since the amount you would pay with PAYE is more than the standard ten-year repayment plan
- You don’t want to pay student loans for 20 years, and would rather suffer up front to get out of debt sooner
- You hope to earn more money in the future and would rather pay down your loans as much as possible now
The Bottom Line
While over 40 million Americans now deal with some level of student loan debt, the PAYE program – and other income-driven loan forgiveness programs – were created to ease the burden for individuals who meet certain income guidelines. The PAYE program in particular has gained steam due to the President’s insistence on capping loan payments at 10 percent of discretionary income, vs. 15 percent with IBR.
If you want to learn more about how you can qualify, compare your financial situation to the guidelines created by StudentAid.gov. And if your income disqualifies you, you can also consider refinancing your federal and private student loans with a lender that offers better terms and a lower interest rate.
Student loans cannot be discharged in bankruptcy, but they can be forgiven if you opt for a government-sponsored loan forgiveness program and follow the prompts. It’s up to you to decide if it’s worth it.