What are Pay as you Earn (REPAYE) Student Loans?

[This is the second installment in a series examining repaying student loans. Part I was a best practices guide for repaying student loans.]

Pay As You Earn (PAYE) was introduced in December 2012 and has been widely touted as one of the best options for those struggling to pay back their student loans. Why is this? PAYE is an income-driven payment plan for federal student loans that caps the monthly payment amount at 10 percent of your discretionary income.

The U.S. Department of Education considers discretionary income to be “the difference between your income and 150 percent of the poverty guideline for your family size and state of residence.” So let's do some math using the following assumptions:

  • A new graduate
  • Who attended a public, four-year institution
  • Has the average (according to the Department of Education) student loan balance of $26,946
  • Is single
  • Makes $35,000 per year
  • Lives in the lower 48 states, where the 2015 poverty guideline for that family size is $11,770

To determine this person's discretionary income, you take the salary and subtract 150 percent of the poverty guideline (so, $17,655), to get $17,345. That works out to about $1,445 per month. Now, to determine their monthly payment under PAYE, you take 10 percent of that, which is $145. That's over $125 less per month than the amount under the standard plan, which is $272. Plus, if this person loses their job, their required payments could be as low as $0 per month.

The problem with PAYE

The problem with PAYE is that in addition to meeting the income requirements, “you must also be a new borrower as of Oct. 1, 2007, and must have received a disbursement of a Direct Loan on or after Oct. 1, 2011.”

To be considered a new borrower, you must have had no outstanding Direct Loans or FFEL Program loans prior to the 2007 eligibility date.

That means if you have been out of school for awhile but are still struggling with loans, you're left out of the PAYE loop entirely.

In that case, your best option is Income-Based Repayment (IBR), which caps monthly payments at 15 percent of discretionary income. Using our example above, that amount would be $217 per month, almost $75 more per month than that lucky duck on PAYE.

Obviously, this isn't a perfect comparison. Hopefully, the person on IBR graduated with less debt, has been making payments longer, and is making more money by now. But under the apples-to-apples comparison here, PAYE beats the pants off IBR.

Introducing Revised Pay As You Earn (REPAYE)

Recognizing that PAYE wasn't helping everyone who was struggling, in June 2014 President Obama directed the Department of Education to take further action to help student loan debtors. The result is Revised Pay As You Earn (REPAYE), which takes effect in December 2015. Students in the Direct Loan program who meet the criteria can participate regardless of when their loans were issued.

According to the Department of Education, REPAYE will:

  • Enable 5 million additional borrowers to cap their monthly payments at 10 percent of their discretionary income, and
  • Offer a new interest subsidy benefit so that balances don't grow as rapidly for debtors whose required monthly payments don't keep up with accruing interest.

However, it's not all rainbows and puppies. From what I've heard about the plan, there are two big drawbacks to REPAYE.

Drawback 1: Married couples might pay more

Under REPAYE, both spouses' income and federal student loan debt is considered when determining the monthly payment, regardless of whether they file federal tax returns jointly or separately. Under both IBR and PAYE, if spouses file separately, only the applicant's income and debt are considered. So if, for example, only one spouse has student loan debt and/or one spouse is a high earner, REPAYE might not result in the lowest monthly payment.

However, spouses filing separately can't take the student loan interest reduction, which is valuable because it is an above-the-line deduction, meaning that you can take it in addition to the standard deduction even if you don't itemize. So if you had previously been filing separately to qualify for IBR and you and/or your spouse's payments would be lower under REPAYE, you can probably file jointly and get the student loan interest deduction as well.

Drawback 2: No monthly payment cap

Under both IBR and PAYE, the monthly payment is capped at what it would have been under the standard repayment plan. REPAYE doesn't have a monthly maximum payment, so if your income takes off, you could wind up paying more per month than you would under the standard plan. Potentially significantly more. And if you switch from REPAYE to another plan to avoid that outcome, any outstanding interest will be capitalized.

It's unclear, but depending on whether the payment amount is based on your gross income or your adjusted gross income, it might be possible to artificially lower your income in a variety of ways. That would enable you to max out certain retirement vehicles as well as HSA and 529 accounts while keeping your student loan payments low, so you don't have to decide between investing and paying off student loan debt.

Other things to keep in mind

First, under any federal income driven repayment plan, whether it's IBR, PAYE, or REPAYE, any unpaid balance would be forgiven at the end of the repayment term. However (and this is a BIG however), the amount that is forgiven is taxed as income. Depending on what marginal tax bracket you find yourself in 20 or 25 years down the road, that could mean a BIG tax bill. And if you think your student loan servicer is aggressive, wait until you owe money to Uncle Sam.

In other words, if you choose any of these plans, try and calculate how much you will owe in taxes upon forgiveness and stash that money in a high-yield online savings account. Since you don't really have any way of predicting your income over a 20-year period or what tax rates will be two or more decades from now, good luck with that!

Second, because your minimum payments may not cover your interest, your balance may rise over the course of repayment. The interest rate subsidy under REPAYE should help with this, but it's hard to predict in advance how much. So if the idea of potentially making payments for 20+ years without making any headway on your balance gives you the heebies, then psychologically speaking it may be better for you to tighten your belt in the short term and pay the debt off sooner.

However, you can always pay more than the minimum on any repayment plan. So if REPAYE would give you financial breathing room now, it may be a good idea to switch to the plan and then pay off your debt more aggressively down the road as you are able.

[Note: I am not a tax or student loan professional. Consult a tax professional and/or the Federal Student Aid website and/or your student loan servicer(s) before deciding what repayment plan is the best fit for you.]

That said, what are your thoughts on REPAYE? If you are eligible, will you be making the switch?

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Kalie @ Pretend to Be Poor
Kalie @ Pretend to Be Poor
4 years ago

This is very informative and I’m glad there are some options for people who simply can’t repay their loans, but this is just a Band Aid for a bigger problem. Why are teenagers allowed to take out huge loans, at times way out of proportion without the earning potential in their chosen field? I wish more parents, educators, and financial and academic advisors would address this issue at its starting point.

JGfromSTL
JGfromSTL
4 years ago

Agreed. My 17 year daughter has worked hard for decent grades, which affords her two years of tuition and fees at any CC in the state through the MO A+ program. Instead she wanted to go to a $16k+ per year school, because, well, most of her friends are doing it, though she does not know what major she wants. I had to sit her down and chart out two financial charts, one based on the typical progression and the other on an optimized progression, where she could minimized debt, while maintaining income and increasing her net worth. She didn’t… Read more »

Jim
Jim
4 years ago

I’m currently on PAYE, and I’m considering switching to REPAYE. Here’s my thinking: I’m single, and I intend to aggressively pay down my student loans. My loan balance is large, so the interest subsidy is going to be a significant benefit in the short term. That said, I need to figure out whether the interest subsidy will be based on the difference between accrued interest and minimum REPAYE monthly payments, or between accrued interest and the amount I actually pay in a month. If it’s the latter (or if it can be manipulated by making lump sum payments, targeting specific… Read more »

Sandra Reif
Sandra Reif
4 years ago

I am 65 years old,undergoing divorce, income $55,000. I had a Sallie Mae loan (my husband and I) for 3 children undergraduate only. Originally Sallie Mae,now Navient. Is there anything we are eligible for. Interest rate 8% and my youngest child is now 44 years old. Thank you for your help.

Casey
Casey
4 years ago

Great article, especially for me seeing as how I will be graduating from my Master’s Program next month and will have to be adjusting my repayment plan to ensure I can pay all of my obligations.

Also, you were quoted here: http://www.thestreet.com/story/13362771/3/repaye-is-the-new-next-big-think-for-student-loans.html

I don’t know if you knew!

Ash
Ash
4 years ago

I wonder if you still have the option beginning Dec to choose the original PAYE as repayment plan if you have all the eligiblity criteria for it like me , my grace period on my loans would be over soon and I have to make a repayment plan Decision but I wonder if PAYE would still be available by then ( mid Dec to Jan ) , and if so and I choose it , can they or will they then force me to change over to REPAYE later ? ( I have had loans for both undergrad & grad… Read more »

Edwina
Edwina
4 years ago
Reply to  Ash

All of the IDR options will still be available to all eligible borrowers. It does sound like PAYE would be a better option for you, as REPAYE would automatically extend your loan term to 25 years. You can request any repayment plan you want, your servicer can also assist in figuring out what plan is best for both short term and long term options. Ash: The interest subsidy on PAYE is for three years, with no stopping. The subsidy will cover the unpaid interest accrued on subsidized federal loans for the first 3 years you are on the program. This… Read more »

Jennifer
Jennifer
4 years ago

I am a public teacher for the past 2-years and need to know if I can switch to REPAYE this December 2015 with making my required 120 payments for loan forgiveness at the end of my 10th year? I have been paying two years on Standard Loan repayment to date and I drowning and need to do something fast as on a teacher salary for public schools in Title I have very little disposable income.

EH
EH
4 years ago
Reply to  Jennifer

According to this and the Federal Loan servicing website (http://ticas.org/blog/new-income-driven-repayment-plan-now-available-all-federal-direct-student-loan-borrowers-repaye) you can change your repayment plan at any time.

Ben
Ben
3 years ago

Good info, thanks. In some ways, the REPAYE plan could be looked at as a hedge against inflation, as my (rather large) direct consolidation loans have fixes interest at 7.25%. That’s a bit high for a loan to hold onto for 20 years (or more), but with the interest subsidy the effective interest rate could perhaps be calculated at about 4%, or roughly the same as a typical mortgage these days, which can also be viewed as hedges against inflation. I calculated the approximate total money I would pay on REPAYE with the minimum versus going all out to pay… Read more »

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