Pay-as-you-earn repayment (PAYE) is an income-driven repayment plan that bases student loan payments on 10 percent of the borrower’s discretionary income, which is defined as the amount by which adjusted gross income exceeds 150% of the poverty line. The remaining debt is forgiven after 240 payments (20 years). Generally, borrowers whose debt at graduation exceeds two-thirds of their annual income will have a reduced monthly payment under PAYE.
PAYE is available only for loans in the Direct Loan program.
Two Versions of PAYE
There are technically two versions of PAYE, depending on when the borrower switched into PAYE.
Congress changed the income-based repayment plan to base the monthly payment on 10% of discretionary income and to limit the repayment term to 20 years instead of 25 years, starting on July 1, 2014.
To qualify for the reduced payments and repayment term, the borrower must be a new borrower as of July 1, 2014. This means that the borrower has no outstanding federal student loans as of July 1, 2014.
President Obama used his regulatory authority to make PAYE available before the statutory effective date by transforming the regulations for the income-contingent repayment program into the PAYE program.
Because the program had to be cost neutral – only Congress can appropriate funds – eligibility for the early implementation of PAYE was limited to borrowers who had no loans prior to October 1, 2007 (i.e., new borrowers as of that date) and at least one loan disbursed on or after October 1, 2011. This version of PAYE became available on December 21, 2012.
Lowest Payments among the Income-Driven Repayment Plans
Because PAYE has a lower percentage of discretionary income, a shorter repayment term, payments are capped at Standard Repayment and there is no marriage penalty, PAYE has the lowest payments of any of the income-driven repayment plans.
This is in contrast with the Revised Pays-As-You-Earn Repayment (REPAYE) plan, where graduate students have a longer repayment term, there is no cap on loan payments when income increases, and borrowers are subject to a marriage penalty even when they file tax returns as married filing separately.
Pay-as-you-earn repayment requires the borrower to pay 10% of discretionary income, instead of 15%.
PAYE caps the monthly payment at the standard payment amount based on the loan balance when the borrower started PAYE. So, when a borrower is no longer eligible for a reduced payment because their income has increases, PAYE limits the monthly payment from growing larger.
The minimum monthly payment is $10.00 under PAYE, unless the calculated payment is less than $5.00, in which case the monthly payment is zero. This is the same as for income-based repayment. For example, if the borrower’s income is less than 150% of the poverty line, the monthly loan payment will be zero.
The remaining debt is forgiven after 20 years of payments (240 payments) under PAYE. The forgiveness is taxable under current law.
Public Service Loan Forgiveness (PSLF) cancels the remaining debt after 10 years of payments (120 payments). The forgiveness under PSLF is tax-free under current law.
No Marriage Penalty
Like IBR and ICR, but not REPAYE, PAYE does not have a marriage penalty. If the borrower is married and files a joint federal income tax return with his or her spouse, discretionary income will be based on the joint income. However, if a married borrower files his or her tax returns as married filing separately, the loan payments will be based on just the borrower’s income.
Treatment of Accrued but Unpaid Interest
Borrowers can be negatively amortized under PAYE, since the payments can be less than the new interest that accrues. This may lead to accrued but unpaid interest.
The federal government pays 100% of the accrued but unpaid interest on subsidized loans but not unsubsidized loans during the first three years under PAYE. After the first three years, the federal government does not pay any interest on subsidized or unsubsidized loans under PAYE.
Accrued but unpaid interest is capitalized under PAYE until it reaches 10% of the original loan principal balance. Interest subsequently capitalizes at loan status changes, such as when the borrower is no longer eligible for PAYE or switches to a different repayment plan.
Example of Loan Payments under PAYE
Consider a borrower who owes $30,000 in federal student loans with a 5% interest rate and has an AGI of $25,000 per year. The monthly payment under standard 10-year repayment is $318.20.
The 2019 poverty line in the continental U.S. for a family of one is $12,490. The borrower’s discretionary income is $25,000 – 150% x $12,490 = – $6,265. When discretionary income is negative, it is treated as though it were zero. Thus, the monthly payment is zero under PAYE at this income level.
The 2019 poverty line in the continental U.S. for a family of four is $25,750, greater than the AGI. Since discretionary income is zero, the monthly loan payment will be zero.
A pay-as-you-earn repayment calculator can be used to determine personalized estimates of the monthly payments and total payments under PAYE.