Federal student loans make it possible for millions of Americans to attend college every year. Unfortunately, when student loans move out of their six-month grace period (once you graduate from school or stop attending college), some borrowers find it difficult to keep up with the payments. If this happens, you might be able to lower your monthly payments or alter your loan terms through an income-driven repayment plan (IDR).
Two popular IDRs are the Pay As You Earn (PAYE) Plan and the Revised Pay As You Earn (REPAYE) Plan. The choice of PAYE versus REPAYE comes down to your level of financial hardship and your desired repayment period.
What is income-driven repayment?
Income-driven repayment (IDR) plans are programs that base your monthly student loan payments on your actual income. These plans are one of the primary perks of using federal loans versus private loans to finance your college education. An IDR can slash the size of your monthly payment and, in some cases, may result in partial forgiveness of your federal student loan debt.
The catch with IDRs is that not everyone can use this benefit; they’re only available for certain types of federal student loans. Eligibility may also be based on your income and family size. Often, though not always, you need to demonstrate financial hardship on an IDR application in order to qualify.
You must also recertify your continuing eligibility each year if you’re using an IDR. Should your income or family size change, the Department of Education may need to adjust your repayment terms, or you may no longer qualify to participate in your chosen IDR plan.
It’s also important to note that amid the coronavirus pandemic, federal student loans held by the U.S. Department of Education are eligible for a payment pause and interest waiver through Dec. 31, 2020. If you are currently in an income-driven repayment plan, suspended payments during this time will count toward income-driven repayment forgiveness. If your income has been affected by the coronavirus pandemic, you can also update your information to qualify for a lower monthly payment amount once the administrative forbearance period ends.
What is Pay As You Earn?
Pay As You Earn is an income-driven repayment plan that generally bases your monthly payments on 10 percent of your discretionary income. The Department of Education defines discretionary income as the difference between your annual income and 150 percent of your state’s poverty benchmark (determined by family size). In other words, it’s the money left over after you pay standard expenses for a family of your size (rent, utilities, food, taxes, etc.).
Your payments as part of this program, however, cannot exceed what you would pay under the standard 10-year repayment plan. Additionally, “if a married borrower files separate returns, the loan payment is based on just the borrower’s income, not the joint income,” says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com. He adds that PAYE yields the lowest monthly loan payments for most borrowers.
If you qualify for PAYE, your repayment term will last for 20 years. At that point, your remaining student loan balance should be eligible for forgiveness. But if you also qualify for Public Service Loan Forgiveness, your remaining loan balance may be forgiven after just a decade.
What is Revised Pay As You Earn?
Revised Pay As You Earn paved the way for millions of federal student loan borrowers who weren’t eligible for other IDRs to potentially lower their monthly payments. REPAYE, like its PAYE predecessor, limits the size of your federal student loan payments to 10 percent of your discretionary income. Repayment terms for the REPAYE plan are 20 years for eligible undergraduate loans and 25 years for eligible graduate loans.
Once you complete the repayment period successfully, your remaining student loan balances may be forgiven. And if you qualify for Public Service Loan Forgiveness, you can use it alongside REPAYE to potentially see your remaining balance wiped out after just 10 years of income-adjusted payments.
Unlike the PAYE program, however, payments for this program are not capped at the standard repayment amount if the borrower’s income grows too high, says Kantrowitz.
“The payments just keep on increasing as income increases,” says Kantrowitz. “In addition, loan payments are based on joint income for married borrowers even if the borrower files a separate income tax return. This is referred to as a marriage penalty.”
Key differences between REPAYE and PAYE
There are many similarities between Pay As You Earn and Revised Pay As You Earn. Yet the plans’ differences can be harder to spot. Here’s a quick cheat sheet to help you compare both options.
PAYE and REPAYE plans are available to eligible borrowers with the following types of federal student loans:
- Direct Loans (Subsidized and Unsubsidized).
- Direct PLUS Loans (except those made to parents).
- Direct Consolidation Loans (except those that repaid loans made to parents).
The PAYE plan is only available if you took out your first federal student loan on or after Oct. 1, 2007. You must also have received at least one eligible Direct Loan disbursement on or after Oct. 1, 2011. The REPAYE plan is more flexible.
With PAYE and REPAYE, your adjusted payments might be too small to cover the interest your loan accrues each month. This is known as negative amortization. But both plans offer help for borrowers facing this problem in the form of an interest subsidy.
Under PAYE, surplus interest charges on subsidized loans aren’t capitalized. (Capitalized interest means that the unpaid interest is added to your loan principal balance.) Instead, the federal government covers the bill for the first three years of your plan. If you leave the plan, limited interest capitalization may occur.
The maximum amount of interest that’s eligible for capitalization on subsidized loans is 10 percent of your loan balance when you started your PAYE plan. You are responsible for paying interest accrual on all unsubsidized loans.
With the REPAYE plan, the Department of Education also covers the surplus interest charges on subsidized loans for up to three years if your payment is too small to pay it.
After three years, the interest subsidy will continue to pick up the tab for half of any excess interest fees that add up on your loan. Eligible unsubsidized loans may receive a 50 percent interest subsidy from day one. Overall, the REPAYE interest subsidy is the clear winner for most borrowers.
Neither PAYE or REPAYE bases your ability to participate on your marital status. However, whether you’re married or single may affect the size of your adjusted monthly payment.
“PAYE is often the best option for someone who is married, and where both spouses are bringing in an income,” says Michael Micheletti, director of corporate communications at Freedom Financial Network. “With PAYE, a married borrower is able to file taxes separately from their spouse so that their spouse’s income will not factor into how loan payments are determined.”
With REPAYE plans, no matter how you file your returns, the Department of Education will take your spouse’s income into consideration when calculating your monthly payment, which could mean a significantly higher monthly bill in households where both spouses work.
How to choose which is right for you
There are several factors to consider when considering REPAYE versus PAYE to alter your student loan payments.
- REPAYE features easier qualification standards. For example, you don’t have to prove financial hardship to participate in the plan. If you’re worried you won’t qualify for PAYE, REPAYE may be a viable alternative.
- PAYE caps your payment size. If your monthly payment is more than you’d pay under the standard 10-year repayment plan, you won’t qualify for PAYE.
- REPAYE is generally better for single borrowers. If you’re married or plan to marry in the future, your spouse’s income could increase the size of your monthly payment.
- PAYE forgives remaining graduate debt sooner. Eligible loans for graduate studies may be forgiven after 20 years under PAYE. With REPAYE, you must participate in the plan for 25 years before you’re eligible for forgiveness of eligible graduate debt.
Can you switch from REPAYE to PAYE?
You can change repayment plans on federal student loans whenever you need to, and you can switch among any of the repayment plans, says Kantrowitz, who suggests contacting your loan servicer if you want to change repayment plans.
However, when looking to switch plans, you must still satisfy the eligibility criteria for the program. You will also want to review the pros and cons of each program and consider carefully whether it makes financial sense to switch from one to the other. In some cases, it may be beneficial.
“For some people it may make sense to switch from REPAYE to PAYE if they’re expecting a major bump in income,” says Micheletti. “In that case, they could take advantage of PAYE’s 10-year Standard Repayment Plan payment cap, which lowers the total amount of the loan, including interest, when the income increases. But for someone with a very large loan, and who may never hit that 10-year Standard Repayment Plan cap, it doesn’t make sense to switch.”
Crunch the numbers with a loan calculator or talk to your loan servicer about your plan to switch programs, as there are many variables to consider.
PAYE and REPAYE vs. other income-driven repayment
The Department of Education offers four income-driven repayment plans in total. If you think an IDR is the best option for you, you should compare the benefits of each plan based on your personal situation (income, family size, loan type, etc.). Borrowers with Direct Loans, for example, may choose between all four IDRs. Those with Federal Family Education Loans, on the other hand, may only apply for the Income-Based Repayment Plan (IBR Plan).
Of course, whether you can satisfy each plan’s eligibility requirements will be a key component in deciding which IDR is the ideal fit. Thankfully, you can submit one IDR application to be considered for all four plans.
Federal Student Aid offers a loan simulator online that can help you crunch the numbers, and Bankrate’s student loan calculator lets you compare monthly payments, interest rates and total interest paid. Your student loan servicer may also be able to assist you.
When to consider refinancing as a better option
Income-driven repayment plans can be a good solution for many federal student loan borrowers. But PAYE, REPAYE and other IDRs aren’t right for everyone.
For example, private student loans are not eligible for federal IDRs. Also, if you have federal student loans but your income is too high to qualify for PAYE (or too high for REPAYE to make sense), you may want to consider refinancing your student loans instead.
When you refinance your student loans through a private lender, there’s a chance that you could secure a lower interest rate – especially now, with the coronavirus pandemic driving interest rates to near record lows. A lower rate might save you money and could potentially help you pay off your debt sooner.
However, refinancing with a private lender also means you’re giving up government benefits if you’re a federal student loan borrower. Income-driven repayment plans and student loan forgiveness, for example, will no longer be an option.
You should take time to review the pros and cons of refinancing federal student loans before you make a final decision.