Student Debt Resource

5: Pay as You Earn (PAYE) Plan

/ Student Debt E-book

The PAYE Plan was first proposed in October of 2011, and officially unveiled at Colorado University by then President Obama, and then First Lady Michelle Obama. At the unveiling, President Obama noted that his inspiration for creating the repayment plan was his own personal experience paying off $120,000 in debt. The plan became effective on December 21, 2012.  

The PAYE plan requires you to pay 10 percent of your discretionary income for 20 years. After 20 years, all outstanding loan balance is cancelled.  

Qualifying for the PAYE Plan 

There are three requirements that borrowers must meet to be eligible for the repayment provisions offered by the PAYE plan: (1) They must be considered a new borrower under the plan, (2) They must have a “partial financial hardship,” and (3) they must have eligible loans 

Requirement #1: The borrower must be considered a “new borrower” under this plan. Only borrowers who take out loans after a certain date are eligible for the plan. This requirement has two prongs: 

  • First, you must borrow your first federal loan on or after Oct. 1, 2007. If you had federal loans from before Oct. 1, 2007, you still can meet this test if you completely repaid those loans before taking out a new loan on or after Oct. 1, 2007. 
  • Second, you must either receive a new loan, receive a disbursement on an existing loan, or consolidate your loans on or after October 1, 2011. 

As a result, many borrowers with loans from 2007 or earlier, as well as students who graduated in 2011 or earlier, and borrowers already in repayment will not be able to benefit from these changes. However, if you do not meet these requirements, you still may be eligible for the REPAYE, IBR or ICR plans.  

Requirement #2: Eligible borrowers must also have a partial financial hardship in order to enroll in the plan. You meet this threshold if the annual amount due on your outstanding Federal Direct and FFEL Loans, under a standard 10-year repayment plan would exceed 10 percent of your “discretionary income.” 

Note: The inability to enter into the PAYE plan now due to a lack of a partial financial hardship, does not mean you can never repay your loans under this plan. Any decrease in income or increase in household size may result in you possessing a partial financial hardship in the future.  

Requirement #3: PAYE can only be used to repay eligible loans. Eligible loans include 

Direct Subsidized  Direct Unsubsidized  Direct Grad PLUS  Direct Consolidation  FFEL Loans If converted into a Direct Consolidation 

Loans that are not eligible include the following:  

  • Unlike IBR, FFEL Loans are not eligible for repayment in the PAYE plan. Any FFEL Loans must first be consolidated into a Direct Consolidation loan before you may enroll in the PAYE plan. 
  • Parent PLUS Loans are not eligible for repayment in the PAYE plan.  
  • Federal Perkins Loans are only eligible for repayment in the PAYE plan when they are part of a Federal Direct Consolidation Loan. Remember to consult with the school from which you obtained your Perkins Loan before consolidating it in order to find out whether you can benefit from Perkins cancellation. These provisions will be lost if Perkins Loans are consolidated! 
  • Federal loans in default cannot be repaid under the PAYE plan.  
Paying under the PAYE Plan 

As long as you maintain a partial financial hardship, you will never pay more than 10 percent of your discretionary income toward your student loan payments under the PAYE Plan.  

Because your monthly payment amount is based on your income and household size, rather than the amount you owe, your monthly payment increases as your income increases. If your income decreases, your monthly payment amount will also decrease. 

In addition to lowering your monthly payments based on income, if you enroll in the PAYE plan and still are repaying your loans after 20 years (excluding time spent in forbearance or deferment other than an economic hardship deferment) any principal and interest remaining on your loans will be cancelled.  

However, if your income increases to a point where you no longer have a partial financial hardship, your payment amount will no longer be based on your income. Instead, it will be set at the amount you would have paid if you had entered a standard ten-year repayment plan when you first entered the PAYE plan. In this case, switching to either the graduated or extended repayment plans might lower your monthly payments, but would also remove your eligibility for Public Service Loan Forgiveness, removing the possibility of loan cancellation in 20 years, and potentially result in accrued interest capitalizing.  

A Look at How the PAYE Plan Helps Dara Defender 

Dara Defender graduated with $65,000 in eligible unsubsidized federal loans. She has a disabled sister for whom Dara provides 80 percent of support. Dara is single and has two children. This means Dara has a household size of 4. Her loans have a 6.8 percent interest rate. Dara took a job earning an adjusted gross income of $60,000. 

Does Dara qualify to repay her loans under the PAYE plan? 

Remember that Dara must meet three requirements to enroll in the PAYE plan: (1) have a partial financial hardship, (2) be a new borrower, (3) have eligible loans. 

Does Dara have a partial financial hardship?

Yes. Under the Standard repayment plan, Dara would have monthly payments of $748 but would only have payments under the PAYE plan of $196. Because Dara’s payments under the PAYE plan would be lower than her payments under the Standard plan, Dara has a partial financial hardship.  

Reminder: You can easily use the loan simulator to determine whether you have a partial financial hardship. As noted above, if you log in and the loan simulator does not provide a monthly payment for PAYE plan (using your provided information), then you do not possess the required financial hardship and cannot repay your loans under the PAYE plan. 

Is Dara a new borrower?

Yes. Dara had no unpaid federal loans as of October 1, 2007, AND she took out a Direct Loan after October 1, 2011. Because she meets both requirements, Dara is a new borrower for PAYE plan purposes.  

Does Dara have eligible loans?

Yes. Because Dara took out her federal loans after 2011, Dara can only have Direct Loans. FFEL loans (the other type of federal loan that cannot be repaid under the PAYE plan) were no longer made after 2010. 

Dara meets all three requirements for a PAYE plan and can repay her loans under this plan.  

How will Dara benefit from the PAYE plan? 

During her first year in the PAYE plan, Dara’s monthly payments will be $196 (almost $100 less than IBR for a non-new borrower). As noted above, Dara would pay more than three times as much – around $748 per month – under the Standard plan.  

Let us assume Dara receives annual salary increases of five percent, with gradually rising monthly payments. She remains in the plan for 20 years and in year 20, Dara pays about $748 per month. 

At the end of year 20, Dara has paid about $106,000 and her remaining balance of principal and interest (about $43,807) is cancelled. 

Under a standard 10-year plan, Dara would have paid about $89,763 and would have had to pay about $748 per month, every month. Under an extended plan, Dara would have paid about $135,344 (twice the amount she borrowed) over 25 years and would have had to pay about $451 per month regardless of income. Under a graduated plan, Dara would initially pay about $431 per month, but these payments would rise gradually regardless of her income and she would pay about $96,590 over ten years.