The Standard Repayment Plan — the default repayment plan for federal loans — works for many graduates. But if your loan balance is high and your income is low, this plan may not be an affordable option for paying back your student loans.
Thankfully, most federal loans are eligible for an income-driven repayment plan, which takes into account how much you make. Let's take a look at the specifics of a popular income-driven plan, the Pay-As-You-Earn Plan, to see if it's a good choice for you.
What is PAYE?
The Pay As You Earn repayment plan is one of four income-driven plans offered for federal student loans.
Under this plan, your monthly payment would usually be capped at 10% of your discretionary income for a period of 20 years.
The upshot: You'll get a lower monthly payment than you would under the 10-year Standard Repayment Plan.
Even better, any remaining balance will be forgiven after 20 years — although you'll have to pay taxes on that amount. PAYE is also an eligible payment plan if you qualify for Public Service Loan Forgiveness.
Do I qualify for PAYE?
To qualify, you must meet two basic criteria. They are:
You borrowed your first federal student loan on or after Oct. 1, 2007, and
You took out a federal Direct Loan or Direct Consolidation Loan on or after Oct. 11, 2011.
Because income-driven plans are meant to help borrowers who struggle making their loan payments, you must also be able to prove partial financial hardship.
For the PAYE plan, "partial financial hardship" means that the annual amount due on your eligible loans under the Standard Repayment Plan exceeds 10% of the difference between your adjusted gross income (AGI) and 150% of the poverty line for your family size in the state where you live.
But listen ... don't sweat the calculation too much. Instead, just call your lender ask if you qualify.
When is PAYE a good idea?
If you struggle to make your monthly loan payments, PAYE can be a good alternative to the Standard Repayment Plan.
Because this repayment plan caps your payments to 10% of your discretionary income, it will lower your monthly payment.
It is especially beneficial if your regular monthly payments are disproportionately high compared to your take-home income.
What are the benefits of PAYE?
In addition to lower monthly payments, PAYE offers forgiveness on the loan balance after 20 years is up, as long as you've made all your payments.
That means if you have a very low income, you could save money compared to the Standard Repayment Plan.
As an example, let's say you have a student loan balance of $40,000 at 6% interest. Your income is $20,000 and increases annually only 1.5%.
Under the standard option, your monthly payments would be $444. You would pay a total of $53,290 over 120 months before you satisfied the loan.
But under PAYE, your monthly payments would start at $16 and gradually increase to $185 over the course of 20 years. (Remember, payment amounts increase as your income increases.) You would pay a total of $20,464 over 240 months, and then your remaining balance would be forgiven. BUT ... keep in mind that you'd still pay taxes on that amount.
How is the monthly payment calculated?
PAYE monthly payments are typically 10% of your discretionary income.
Check out the U.S. Department of Education's Pay-As-You-Earn calculator to see your projected monthly payment.
How do I enroll in PAYE?
You can enroll in PAYE by filling out an application through the government online.
There no application fee to complete this application, and the process only takes 10 minutes or less. You'll be asked about your financial situation, so be prepared with documents that prove your income, like a W-2.
What kind of loans are eligible?
Qualifying loans include:
- Direct subsidized and unsubsidized loans
- Graduate PLUS Loans (but not Parent PLUS Loans), and
- Consolidation loans made after October 1, 2011, as long as the consolidation loans do not include Direct or Federal Family Education Loans (FFEL) made before October 1, 2007.
Want to see if PAYE or another income-driven repayment plan could work for you? See how they compare.