Pay as You Earn (PAYE) vs. Income-Based Repayment (IBR) Plans
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What Is PAYE and How Does It Work?
You borrowed your first federal loan on or after Oct 1, 2007. You received a distribution of a Direct Loan on or after Oct 1, 2011. Your payments under PAYE would be less than what you would pay with a standard 10-year repayment plan. Your federal loans are not in default, meaning you have stopped making payments altogether.
Pros and Cons of PAYE
Pros of PAYE
Lower monthly payments. PAYE caps monthly payments at 10% of your discretionary income. Your monthly payments will never exceed the amount you would have otherwise paid with a standard 10-year repayment plan. Loan forgiveness after 20 years. Once you’ve made payments on your loan for 20 years, your remaining balance will be forgiven. Spousal income is excluded from the income calculation. If you’re married and choose to file your taxes separately, your spouse’s income isn’t accounted for when determining your loan payment. This way, if your spouse makes more than you, it won’t hurt your chances of qualifying for PAYE. Still, it can be smart to speak with a tax professional to ensure filing separately is the way to go. Assistance with interest. If you no longer qualify for the plan, the amount of unpaid interest that can be re-added is capped at 10% of your original balance. However, this benefit won’t apply if you leave the plan.
Cons of PAYE
Only available for new borrowers who qualify. For eligibility, you must be a new borrower who applied for federal loans on or after Oct 1, 2007. Must reapply every year.It’s up to you to reapply for PAYE every year to verify that your financial situation has not changed. If you drop the ball and don’t reapply, your unpaid interest will return to your remaining loan balance. Additionally, your monthly payment will increase until it matches what it would have been on a standard 10-year repayment plan. Potential to cost you more than expected. Over 20 years, a lot of things can change. You can start a family, switch jobs, or get a divorce, which can impact your eligibility. So, be mindful that if you no longer qualify for PAYE, you must repay your unpaid interest. The government treats the forgiven balance as taxable income. Therefore, once you reach the 20-year mark and your remaining balance is forgiven, you must pay income taxes on the forgiven amount. As a result, your tax bill could cost you several thousand or more, depending on the amount of any remaining balance.
What Is IBR and How Does It Work?
Your payments under IBR would be less than what you would pay with a standard 10-year repayment plan (usually applicable if your federal student loan debt is higher than your annual discretionary income or a significant portion of it). Federal loans cannot be in default, meaning you stopped making payments.
Pros and Cons of IBR
Pros of IBR
Capped monthly payment amounts.New borrowers' payments will never exceed 10% of their discretionary income as long as the borrowed loans are on or after July 1, 2014. At the same time, borrowers who applied for federal loans before July 1, 2014, will only have to make 15% of their discretionary income payments. In both cases, payment amounts are usually less than if you were making payments on a standard 10-year repayment plan. Loan forgiveness after 20 or 25 years of consecutive payments. If you're considered a new borrower (took loans on or after July 1, 2014), your remaining loan balance can be forgiven within 20 years. For those who took out their loans prior to that date, their loans will be forgiven after 25 years. Spousal income is excluded when filing taxes separately. Like PAYE, you don't have to include your spouse's income if you file your taxes separately. This way, you won't be penalized if your spouse makes more than you do.
Cons of IBR
Must reapply every year. Every year you must reapply for IBR. If you forget to recertify your income and family size, your payments will resort to the standard 10-year repayment plan amount. Any unpaid interest is then added to your remaining balance, increasing your total debt. Borrowers that took out federal loans before July 1, 2014 have longer terms and higher payments. If you borrowed federal loans before July 1, 2014, your loan term is 25 years, plus you must make payments that are 15% of your discretionary income. Folks that took out loans after this date have 20-year terms and must make payments that are 10% of their discretionary income. The government treats forgiven debt as taxable income. This means you must pay taxes on the forgiven balance if your loan term has expired and your debt is forgiven. Unfortunately, depending on the amount forgiven, this could be a large chunk of change.
PAYE vs IBR Compared
Other Options to Reduce the Cost of Student Loans
Student Loan Refinancing
Student Loan Forgiveness
Have made 120 qualifying loan payments Are working full-time Work for a qualifying employer Teach full-time for five complete and consecutive years Work at a qualifying low-income school or educational service agency
Student Loan Grants for Repayment
Frequently Asked Questions
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