How PAYE Calculates Your Monthly Payment
The PAYE plan determines your monthly payment using a specific formula designed to be affordable based on your earnings.
- Payment Formula: Your payment is set at 10% of your discretionary income.
- Discretionary Income: This is calculated by taking your adjusted gross income (AGI) and subtracting 150% of the federal poverty guideline for your family size and state of residence.
- Payment Cap: Your monthly payment will never be higher than what it would have been on a 10-Year Standard Repayment Plan. This cap protects you from excessively high payments if your income increases significantly.
To remain on the plan, you must recertify your income and family size annually. Failure to do so will result in your payment reverting to the standard amount, and any accrued interest may be capitalized (added to your principal balance).
Loan Forgiveness Under PAYE
After making 240 qualifying monthly payments, which equates to 20 years on the plan, any outstanding loan balance may be eligible for student loan forgiveness.
It is important to note the tax implications. Due to the American Rescue Plan Act of 2021, federal student loan forgiveness is not considered taxable income through the end of 2025. However, Congress will need to act for this tax-free status to continue beyond that date.
Who Is Eligible for the PAYE Plan?
While the plan is closed to new entrants, understanding its original eligibility rules is helpful for those currently enrolled.
- Enrollment Status: The PAYE plan is no longer accepting new applications as of July 2023. Only borrowers already enrolled in PAYE can remain on the plan.
- Original Borrower Requirement: To have qualified, you must have been a “new borrower.” This meant you had no outstanding balance on a federal Direct Loan or FFEL Program loan as of October 1, 2007, and received a Direct Loan disbursement on or after October 1, 2011.
- Partial Financial Hardship: You must have demonstrated a partial financial hardship, meaning your calculated PAYE payment was less than what you would owe under the 10-Year Standard Repayment Plan.
PAYE vs. SAVE: Should You Switch?
For borrowers currently on PAYE, the biggest question is whether to switch to the newer Saving on a Valuable Education (SAVE) Plan. The best choice depends on your specific financial situation, particularly your income and whether you have graduate school debt.
| Feature | Pay As You Earn (PAYE) | Saving on a Valuable Education (SAVE) |
|---|---|---|
| Monthly Payment | 10% of discretionary income (capped) | 5% for undergrad loans, 10% for grad loans (or a weighted average) |
| Interest Subsidy | Covers unpaid interest on subsidized loans for the first 3 years only. | Excellent. The plan covers all unpaid accrued interest each month, preventing your balance from growing. |
| Forgiveness Term | 20 years for all loans. | 20 years for undergraduate loans, but 25 years for any graduate school loans. |
| Spousal Income | If you file taxes separately, your spouse’s income can be excluded from the payment calculation. | If you file taxes separately, your spouse’s income is automatically excluded. |
The SAVE plan’s interest subsidy is its most powerful feature, potentially saving borrowers thousands of dollars. However, graduate school borrowers on PAYE may achieve forgiveness five years sooner than they would under SAVE. To compare your exact costs, use the Loan Simulator tool on StudentAid.gov.
External Resources:
For more detailed information, visit the official Federal Student Aid page on Income-Driven Repayment Plans.
