Towards the end of December, a new federal Pay As You Earn repayment plan for student loans became available.
If you’ve taken out a federal direct student loan within the last few years, you may be eligible for Pay As You Earn (PAYE). Eligibility could mean a reduction in not only your monthly payments, but also forgiveness after a period of time.
A lot of 20somethingfinance readers have shown a strong interest in student loan repayment strategy, and for good reason. The student loan debt in the United States has surpassed the $1 trillion mark (and credit card debt) and is rapidly increasing along with tuition inflation. It’s turning into a national crisis.
For some, this new plan may alleviate some pain, so I’ll cover all of the basics on the Pay As You Earn plan in a Q&A format so you can determine if it might be a good option for you.
What is Pay As You Earn?
Pay As You Earn is a brand new federal student loan repayment plan through the Department of Education’s Federal Student Aid office.
It’s not too dissimilar from the previous (and still existing) Income-Based-Repayment (IBR) plan, with two key differences and primary benefits:
- Payment Caps: for Federal Direct Student Loans at 10% of discretionary income for eligible borrowers (IBR is 15%).
- Forgiveness: There is a 20-year forgiveness benefit (10-years for public service) versus 25 years for IBR. For eligible loans, if they are not paid in full after 20 years, the remainder is forgiven.
Why would you Switch to Pay As You Earn?
Typically, student loan repayment is based on a specified number of years. Federal Direct loans, for example, are 10 years with an extended 25-year option.
The monthly loan payment is then determined by taking the amount you owe, adding in interest, and dividing by the number of months. If you have a significant amount of student loans and not a significant income, this can lead to financial hardship. These standard plans are not based on your actual income, but simple, unforgiving math.
Pay As You Earn attempts to address this problem and offers a means (with the 10% of income payment cap) to avoid undue hardship created by student loan payments that are too high.
What Types of Loans are Eligible?
Only the following Direct Loans are eligible for Pay As You Earn:
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans made to graduate or professional students
- Direct Consolidation Loans without underlying PLUS loans made to parents
This means that Direct PLUS Loans made to parents, Direct Consolidation Loans that repaid PLUS loans (Direct or FFEL) made to parents, FFEL Program loans (which are eligible for IBR), and private education loans are all ineligible for Pay As You Earn.
Who is Eligible for Pay As You Earn?
Eligibility and payments are based on your eligible student loan balance, your state of residence, your adjusted gross income in relation to the poverty line, tax filing status, and family size. You must have a “partial financial hardship” to qualify. Sounds complicated, right? The Student Aid Office has a Pay As You Earn calculator to help you figure out your exact payments.
The good news is that once you’re in, you can continue to make payments under the plan even if you no longer have a partial financial hardship.
You must be a new borrower (no outstanding balance on a Direct Loan or FFEL Program loan as of Oct. 1, 2007, or had no outstanding balance on a Direct Loan or FFEL Program loan when you received a new loan on or after Oct. 1, 2007).
The loans must have been taken out after Oct. 1, 2007 and received at least one disbursement after October of 2011.
How do I Apply?
If you are eligible, you can apply for Pay As You Earn here.
Any Downsides to Pay As You Earn?
There are a few:
- If you are extending the terms of your payback period, you might actually be paying more in interest over the life of the loan.
- You must file paperwork documentation annually to determine your payment amount.
- You may have to pay taxes on unforgiven amounts (which is still much better than paying the amounts).
Pay As You Earn Discussion:
- If eligible, will you be applying for Pay As You Earn? Why or why not?
- If ineligible, does a program like this appeal to you?