One of the great advantages of federal student loans is the ability to enter into a loan repayment plan that tracks with your income. Called Income Driven Repayment (IDR) plans, these programs can make your payment much more affordable, and forgive any unpaid balance, if any, at the end of the maximum repayment period.
The two most recently introduced plans are Pay As You Earn (PAYE) and REvised Pay As You Earn (REPAYE). But they each come with their own set of advantages and disadvantages, and knowing what they are is key to making the right choice for your loans.
Pay As You Earn (PAYE)
During his Presidency, Barack Obama created an IDR plan called Pay As You Earn (PAYE). Designed for repayment of loans taken out by current college students, and those enrolling in the future, it introduced several improvements on the existing Income Based Repayment (IBR) plan. The Pros were:
- A shorter maximum repayment period (20 years instead of 25)
- A lower cap on payments (10% of your disposable income, rather than 15%)
- If 10% of your disposable income exceeds a payment under standard repayment terms, then it is capped at the standard payment
- If you and your spouse file separate tax returns, you can base your payment on your income alone
However, there are a couple of Cons to this plan having to do with eligibility. Since it was designed to help current and future students, in order to enroll in it:
- You cannot have any student loan balances as of October 1, 2007
- You must have taken out a federal student loan on or after October 1, 2011
In addition, as is true of any income driven repayment plan, the forgiveness of any unpaid balance can have tax consequences under our current tax code (the amount of the forgiveness is considered taxable income by the IRS).
REvised Pay As You Earn (REPAYE)
Subsequent to the creation of this plan, it was expanded to include all student borrowers, and called REPAYE, for REvised Pay As You Earn. There are definite Cons to this plan, and it should be chosen carefully. The Cons are:
- There is no cap on the monthly payment equal to the payment on a standard repayment plan; it will always be 10% of your disposable income. So if your income rises to the point where you can pay more than that amount, you will be required to do so.
- If you are married, your spouse’s income must be included in the calculations. Under IBR and PAYE, married couples can file separate tax returns, and borrowers can use only their Adjusted Gross Income (AGI). Under PAYE, you cannot.
- The 20 year repayment period in REPAYE only applies to undergraduate loans; loans for professional schools (e.g. law or medicine) or graduate schools have a 25 year repayment period. Under PAYE (and IBR for loans taken out after July 1, 2014) the repayment period is 20 years for all of them.
Any choice of repayment plan for a federal student loan should be made carefully and with the assistance of a student loan professional. The right plan for you could be wrong for someone else.
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