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?
If only I qualified :( Its frustrating that although I work hard and earn a decent wage, I do not qualify for most, if any programs to assist in payments. Still have to live paycheck to paycheck.
How does this encourage or discourage future students from taking out loans they can’t and may never be able to afford?
How do the colleges and universities respond with their tuition rates to this change in demand?
With the current IBR payment plans, how many people make it to the end of the 20 years without repaying the entire loan?
Just a few questions to ponder. My gut reaction is that this will add fuel to the college bubble.
Good questions. To some extent, this could be true. However, I see very few potential students permitting themselves to take out huge loans because of “Pay As You Earn” and anticipated low income upon graduation. That’s a hell of a lot of foresight. More likely, I think this is more of a rescue plan for those who find themselves in tough situations after graduating.
I agree with Paul – imagine if credit card companies said “only make the minimum payments for 10-20 years and after that you’re off the hook” – heck, the college version of myself would have racked up much more if I had known this was around the corner, might have even self-financed a PhD. Call me crazy but my parents taught me to give back what I borrow, whether it’s a library book or $20,000 in student loans.
Maybe instead of offering forgiveness on the end, schools and the governments handing out the loans could do a better job educating the youngins on compounding interest and whether or not they will be able to find a job with their degree from a non-accredited online university with no internship experience. I recently learned of a new career college in Florida that had built more offices for Financial Aid Packaging Staff than for the actual PROFESSORS.
I think you hit the nail on the head with your remedy. The true solution to this problem is to educate children, young adults and adults on basic personal finance and take it from there.
A school’s advisors act acting in the professional function as a financial advisor. If the school has more office space for Financial Aid Packaging Staff than professors, it’s obvious the education is secondary (if even that) to the generated income. The private for profit school (corporate schools) sector has abused it’s position. For example, in 1992, Congress passed rules that forbid schools from paying recruiters based upon the number of students recruited. The penalty was being cut off from federal student loans. Then in 2002 the rules were loosened. Now these schools recruit high school dropouts and recruit in homeless shelters. It’s the mortgage scandal now applied to student loans.
How befitting-just this week I sent out my very last student loan payment!
I went to school for 4.5 years, and was able to pay off over $80k in loans in just 4 years; a goal I set for myself when I first went to school. I also got married and bought a house during that time.
It was through discipline and lots of money saving tips from sites like this one that made it possible.
Thanks GE for sharing your knowledge and inspiring us to strive for financial freedom!
Sorry, but I think that a debt should NEVER be forgiven. Fine if you have to take a loan out to attend college, but pay it back. If you’re not going to be able to pay it back, reconsider what you’re degree is in.
I didn’t have to take a dime of loans out. Get scholarships and work hard and you’ll graduate college debt free.
Same here. If you take out a loan, and agree to certain terms, you shouldn’t seek forgiveness. It’s just wrong. It’s never “forgiven”, it’s just someone elses responsibility to pay for now.
Easy for you 2 say since u were fortunate/lucky enough 2 receive a scholarship. Everyone doesnt get the same advantages you’ve had. Some people work hard all through out highschool/college (minimum wage jobs/work study/classes) and NEVER receive a scholarship. Its easy for you to look down on someone when you sit upon a “high” horse. Make sure you dont drop your lance.
If people who are so gung-ho about chastising those who had to take loans or forego college and rant about forgiveness of loans should also be in favor of eliminating bankruptcy for both individuals and corporations. Why should people be able to walk away from their corporate debts, personal debts, etc., and yet student loans are the one thing you can never walk away from? We let corporations write off billions of dollars every year, but god forbid we do anything to help the average consumer.
No, all loans should be paid back no matter what. No debt should be allowed to be wiped out, I don’t even think a loan should be allowed to be extended. Shame on the lendee for taking on more than they can handle and shame on the lender for giving it to them.
Sorry friend, but I didn’t actually get any scholarships either, but I only applied for 50 or so. I figured that since I had a plan to be able to pay my way with what I had (minimum wage jobs, then a bit better) I shouldn’t take any scholarship away from someone who otherwise wouldn’t go to college at all.
My point is work as hard as possible, take the loan if you must, then REPAY IT! Don’t be a leach on the economy and be responsible. Pay you loans back, all of them.
These programs are a good reason to take out a loan that’s part of a government program instead of just going to the nearest bank. Most of these loans are taken out by people not deemed mature enough to drink, so there might be something to an assumption that they might not have had enough experience to be able to counter all the years of being told to go to college, no matter what it takes. The last time I took out a loan, I talked to a bank officer, supposedly a professional whose advice I should take.
Much of the debt that people have after college comes from the reduced government support for education. There was a time that saving money before college, working through college, and whatever grants were given, was enough for many people to go to college without any loans. Trying to work your way through college now is often impossible.
The idea that people are going to plan on using these programs to allow borrowing a bunch without paying it back is pretty unlikely. Who intends on going to college so that they can spend 20 years at a low pay job, and then after the 20 years have a worthless resume so they can continue to earn low pay until they retire?
When it’s framed as you put it, I agree no one would set themselves up to get a degree that guarantees low pay for 20 years or possibly longer. However, I also disagree that is how the future students will frame the situation. Instead, the message will be to follow your passion because, even if you don’t become wealthy enough to pay off your $100k undergrad degree from a big name school, there will be this safety net down the line. And that will be appealing.
I know not everyone should pick majors based on potential earnings. society already values some degrees enough to subsidize the loans. I believe there are states or counties that will pay off teachers balances if they stay in their system for X number of years. This basically just extends a similar deal, with less favorable terms, to other degrees who don’t have high earning potential.
It’s not so much about deciding on a degree that doesn’t pay much. It’s more of deciding up front that someone will take the lower paying job simply to not have to pay off the loan. Like getting an engineering degree and then deciding to work in fast food just to avoid paying the loan. Sure, with 300 million people in the US, there will be a few people with that kind of thinking. But most people are going to see this as something to avoid. This should be thought of as insurance because the difference between a good income and a bad income is a lot more than what paying off the loan is worth. Consider it this way, what set of circumstances would it take for your medical insurance to pay out $100K – you would really rather not be in the situation where there is a payout.
I like your insurance analogy. The question becomes, how many people will wind up in the situation where the plan has to pay off? And will they all file a claim at the same time? Insurance policies work because actuaries know for 100,000 people covered, they will have to pony up for XX emergencies. An insurance company that misunderstands their exposure gets burned.
I don’t think people will flip burgers to avoid higher paying salaries. The graduates would surely love to make 6 figures and be able to pay off the loan. However, when “disaster” strikes and that Masters of Social Work, earned from the result of taking on lots of student loans, nets you 40-50 grand…what happens then?
College tuition is rising faster than incomes for myriad reasons. I think the end result becomes more graduates who have to make use of this insurance policy. And when more people than expected have to file a claim at the same time, who gets burned? The insurer, or in this case, the government. Thus taxpayers.
I’ll finish with this. Perhaps this subsidization of everyone pursuing degrees that may not pay off is worth it for society. I don’t know the answer. I’m just saying it will cost money.
Ahh….. not exactly. Only direct (from the govt.) loans are eligible. Govt. is making anywhere from 4.8% – 7.8% annual interest, given current rates, on these loans.
So, in effect, if more people sign up for this as a result of the promotion vs. going with a private lender, the government might actually be increasing revenue.
And in the process, it might raise education levels and our competitiveness in the global marketplace.
I’m not saying there aren’t flaws, but I’d trust the numbers have been run. And the scheme is fairly brilliant.
I could probably be eligible and i might use it as a safety net, but pay more than the minimum anytime I could. i have about 200k in student loans, most of that from the two years before I was in charge of my own finances…and I make about 40k a year. I didn’t gain financial literacy until I was about two and a half years into my degree programs, and I decided to just go for it if IBR was there as a safety net. I am happy these programs exist…but the idea of paying the interest on the loans for 20 or more years and failing to pay them off is nauseating. I currently pay above the minimum on my loans because I want them paid down ASAP. Without having done a ton of research to figure out my situation though, I would not have that mentality and could be digging myself an even deeper hole on a program like this. I think these programs need to be paired with legit financial literacy programs. All I knew at 18 was that I had the best chance at an elite school…my life improved greatly and I don’t regret it. I even comfortably support myself. But that is only true because I am making wiser decisions and sacrifices now.
Be careful with forgiven loans. Most people don’t realize that unless you meet certain conditions (for instance, qualifying for the public service loan forgiveness program) you are taxed on the amount of forgiven loans as they are considered income. It is something for which you have to save, and, for most of us, will put you into a completely different tax bracket.
How does this program prevent students from maxing out their student loans and using the additional money obtained for investment purposes (ie: mutual funds, stocks, real estate)since the loan will be forgiven have 20 years? Since one of the requirements of the PAYE program is that your monthly minimum loan repayment has to be less than on a standardized 10 yr plan, it doesn’t make any sense to not max out your student loans….this gives you more flexibility in future earning potential without the risk of getting kicked out of the program. Thoughts?