What Is PAYE and Is It Right for You?

FT Contributor  | 

Managing student loan payments can be challenging, especially if you are in the early part of your career and earning an entry-level salary.

One option for managing your monthly loan payments is a Pay As You Earn (PAYE) repayment plan. PAYE is an Income-Driven Repayment (IDR) plan that caps your payments on federal student loans at 10% of your income. These plans also offer loan forgiveness on the outstanding balance after 20 years of repayment (provided you make your payments on time each month).

PAYE is an excellent option for those who are married, have a consistent income, or have debt from a master’s or Ph.D. program.

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PAYE has some significant advantages for people struggling with student loan debt. Unfortunately, it also has very strict eligibility requirements compared to other income-driven repayment plans.

How to Calculate Your Monthly Payment With PAYE

To calculate your monthly PAYE payment, you first need to determine your discretionary income because the amount due each month is based on this figure.

To calculate your discretionary income, you multiply the poverty line of your state by 1.5. You subtract the answer from your household income.

Poverty levels vary from one state to another and are calculated based on the size of the household. For example, the poverty level for a family of four in the state of Kentucky is $25,100.

If you have a four-person household in Kentucky and have an annual income of $40,000, you would calculate your discretionary spending like this:

  1. Poverty line times 1.5 ($25,100 times 1.5 equals $37,650)
  2. Current annual income minus the answer to step one ($40,000 minus $37,650 equals $2,350).

Your discretionary income is $2,350. Your PAYE payment cannot be more than 10% of this amount. You are going to pay $235 annually or $19.58 monthly.

An easier way to calculate your PAYE payments is to use the online PAYE calculator provided by the Department of Education. This tool can help you figure out monthly payments and also compare payments on a PAYE plan to payments on other income-driven repayment programs.

Requirements to Qualify for PAYE

The eligibility requirements to qualify for PAYE are strict compared to most other income-driven repayment options. PAYE is only for debt from federal student loans. You cannot use the program for private student loans.

PAYE is only for Direct Subsidized and Unsubsidized Loans, Graduate PLUS Loans, and consolidation loans that started in October 2011 or after. In other words, you must have received the loan disbursement no earlier than October 1, 2011.

Parent PLUS Loans do not qualify. If your consolidated loan includes Federal Family Education Loans (FEEL) and Direct Loans from before October 2007, you also do not qualify unless you have paid off these loans already.

Finally, your PAYE payments should be less than what you’d pay with a 10-year Standard Repayment Plan.

How to Know if You Qualify

Assuming your student loan meets all the general requirements, the last step is to make sure that you meet the loan amount and income requirements. This process is most straightforward if you use the online PAYE calculator provided by the U.S. Department of Education.

You enter your financial information, and the calculator will let you know if you qualify for PAYE. The advantage of using this tool is that it will also let you know if you are eligible for other income-driven repayment programs.  

Pros and Cons of PAYE

There are several types of income-driven repayment plans, including Revised Pay as You Earn (REPAYE) and other income-based repayment plans (IBR) as well as income-contingent repayment plans (ICR). Which one is best for you will depend on your circumstances. To make this decision, you need to understand the pros and cons of PAYE.

Pros

  • Under the PAYE plan, you can also qualify for the Public Service Loan Forgiveness program, which will forgive your outstanding loan balance after 120 full monthly payments made on time (10 years of on-time payments). You qualify for the Public Service Loan Forgiveness program if you are a full-time employee of a public service organization.
  • Even if you do not qualify for the Public Service Loan Forgiveness program, but meet the other requirements of the PAYE plan, your outstanding loan balance can still be forgiven after 20 years of consistent payments.
  • Monthly payments get capped at 10% of your income, so student loans do not put undue stress on your finances.
  • In some cases, you can receive assistance on the interest of your loan if you are under financial hardship while on a PAYE plan.

Cons

  • PAYE has stricter requirements than other income-based repayment programs.
  • Because PAYE takes longer than the standard repayment plan (20 years versus 10 years), you will end up paying more interest by the end of the period, even if the monthly payments are lower. If you’re looking to pay off your student loans as quickly as possible, then PAYE may not be the best option.
  • The exact amount you pay under the PAYE plan can change based on your family situation and income. For example, if you get married or if your spouse’s income is higher than yours, the terms of your plan could change.
  • You have to sign up for PAYE every year and provide proof of your income and family situation. This process is known as recertification. If you miss the deadline for recertification, you will automatically get reverted to a standard payment plan.
  • Even upon getting the outstanding loan balance forgiven after 20 years, you may still have to pay tax on the forgiven amount.

How to Apply for PAYE

You may apply for the PAYE program both online and offline through the Department of Education. You can download paper versions of the forms from the Department of Education website and print them out.

To apply online, log in to your Student Loans portal with your Federal Student Aid ID username and password. You can click on the “Start Demo” option to get a preview of what a completed application should look like before you start filling in your information.

When applying, you will have to answer questions related to marital status, family size, your reasons for using PAYE, your address and other identifying information, your tax return information, as well as your contact information. You should have your financial and tax information and current loan information on hand before you start the application process.


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