As spring turns to summer, the minds of many new college graduates turn from elation over graduation to anxiety over impending student loan payments. As a College Coach finance educator, and former college aid counselor, I’ve spoken with countless graduates over the years who express the same sentiment: when they signed for those student loans each academic year, they knew they would have to pay the loans back. Somehow, though, those payments didn’t seem quite real until graduation day came and the student loan bills actually were on the way. That’s when loan amounts that may have seemed reasonable in the abstract can become overwhelming, especially when comparing minimum monthly payments to first full-time paychecks.
New Student Loan Repayment Plan Caps Payments at 10% of Income
Happily, on December 21, 2012, a new student loan repayment plan became available that may provide repayment relief to some of these anxious borrowers. The plan, known as Pay As You Earn (or PAYE), caps federal student loan payments at 10 percent of the borrower’s (and spouse’s, if applicable) discretionary income, which is defined as income above 150 percent of the federal poverty line for the borrower’s household size. PAYE eliminates the hardship of relatively large monthly payments that eat up an entire paycheck for lower-income borrowers. Furthermore, any remaining loan balances are cancelled after 20 years of repayment on the Pay As You Earn plan, though cancelled balances are considered taxable income. Students working in public service are eligible for loan forgiveness after 10 years with no tax liability.
A great relief to borrowers with high loan balances compared to their income, the devil with PAYE is, not surprisingly, in the details. There are many restrictions regarding which borrowers and loans qualify for PAYE.
PAYE Loan Repayment Plan Restrictions Include:
- A graduate must be a new borrower of federal student loans as of October 1, 2007, and must have received a new loan disbursement after October 1, 2011, to be eligible for PAYE. The program therefore only applies to recent and future graduates—earlier borrowers do not qualify.
- Eligible borrowers must be experiencing a partial financial hardship. A partial financial hardship exists when payments on qualifying loans under a standard 10-year repayment plan would be higher than payments calculated under PAYE (i.e. loan balances must be high in relation to income). Borrowers can utilize the Department of Education’s PAYE Calculator to see if they qualify, and income must be documented each year to retain eligibility.
- Only loans borrowed through the government’s Direct Loan program, including Direct Subsidized and Unsubsidized Loans, Direct Graduate PLUS Loans, and Direct Consolidation Loans, are eligible for PAYE repayment. All federal student loans borrowed since July 1, 2010 have been issued through the Direct Loan program, but older student loans may have been borrowed from a bank through the government’s Federal Family Education Loan (FFEL) program. Older FFEL loans can be consolidated into the Direct Loan program in order to gain PAYE eligibility.
- Parent PLUS Loans (and Consolidation Loans including Parent PLUS Loans) do not qualify for PAYE repayment. Therefore, parents struggling with payments on loans they borrowed on behalf of their undergraduate children cannot benefit from the repayment relief offered by PAYE. Note that another (less generous) repayment plan, Income Contingent Repayment, may be available to parent borrowers.
Though restricted in its implementation, the PAYE plan can certainly provide repayment relief for many recent borrowers. Student loan payments capped at a small percentage of income can alleviate some of the repayment stress that is experienced by many new graduates, often facing larger than anticipated loan payments and smaller than expected starting salaries. Borrowers interested in applying for PAYE repayment can do so on www.studentloans.gov.