Recently President Obama announced an expansion to the “Pay As You Earn” (PAYE) student loan income-based-repayment plan. For those with student loans who don’t know what an income-based-repayment plan, or IBR as it is more commonly referred to is, I will explain. In actuality, IBR and “Pay As You Earn” are two different repayment plans for Federal student loans, both of which are contingent on your income (surprise).
Under PAYE, monthly payments are capped at 10 percent of your discretionary income (any income over 150% of the poverty line). Another term of PAYE is that any loans with an outstanding balance are forgiven at the end of 20 years. IBR is similar, but payments are capped at 15 percent and balances are only forgiven after 25 years. Under both plans there has to be a showing of “Partial Financial Hardship.” Partial financial hardship is determined if the monthly amount you would be required to pay on any eligible loan under a standard repayment plan is higher than the monthly amount you would be required to repay under PAYE. There is another significant advantage of PAYE over IBR beyond the percentage cap and forgiveness. Once a person is successfully enrolled in PAYE, the cap will continue to apply even after the person is removed from partial financial hardship. This is not the case for IBR. Under IBR, once a person is no longer determined to be under partial financial hardship, their payments are no longer capped and all accrued interest is capitalized. More importantly, if this happens, payments can become significantly burdensome if one is still within their 10 year standard repayment window because then the payments will have to be made within that smaller window of time. For example, if after 7 years of IBR, it is determined that Joe no longer is suffering from partial financial hardship, Joe will only have 3 years to make his payments (as opposed to the 10 years he would have had at the beginning).
However, the disadvantage is that interest continues to accrue during the lifetime of the plan. This means that even if payments are determined to be $0/month, the interest is accruing. Although some interest is paid by the government on all Direct Subsidized loans and the interest is not capitalized, the loan balance continues to grow. Therefore, what one is saving up front might come back to haunt you later on. In addition, at the end of 20 years, any balance forgiven is treated by the IRS as taxable income (this is not true in the case of a public service loan forgiveness plan).
On June 9th, President Obama signed an executive order expanding the PAYE program to include those people who borrowed before October 2007 or have not borrowed since October 2011. Previously, the plan was available only to any person who took out a federal loan since October 2007 or has received a disbursement before October 2011. It was previously reported that the President’s proposal would also render any balance forgiveness to be non-taxable. However, at this point that does not seem to be part of the executive order. Preliminary reports estimate that this new expansion will apply to 5 million people suffering from student loans. But don’t get too excited just yet because the new plan is not even projected to be available to borrowers before December 2015.
This article is meant to be supplementary. Please see studentaid.ed.gov for more information. Before enrolling in one of these plans, be sure to seek advice from a student loan/tax/financial specialist.