REPAYE vs PAYE: Choosing the Right Plan For You

Deciding between REPAYE vs PAYE, or “Revised Pay As You Earn” vs “Pay As You Earn”, is a tricky endeavor.  Both are forms of an income driven repayment plan and both provide for eventual forgiveness.  However, there are nuances that aren’t so obvious.  These differences over the long-term can mean the difference in paying thousands of dollars more if you choose wrong.

Because you’ve found yourself on this page, I’ll assume you’ve already done some digging into your other repayment options, so I’ll only focus on REPAYE vs PAYE.

Pay as You Earn Repayment Plan

PAYE was introduced by the Obama administration in 2012 in response to Congress revising the existing Income Based Repayment plan (IBR).  The administration didn’t like that congress had put restrictive limitations on who would be eligible for IBR.  So under executive order, President Obama introduced the exact same plan, with one added feature (discussed later) and lessened restrictions on eligibility.  Effectively neutering the revised version of IBR, there is no reason to ever use it over PAYE.

Pay As You Earn utilizes the lowest discretionary income requirement, 10%, and qualifies for forgiveness after 20 years of payments.

REVISED PAY AS YOU EARN REPAYMENT PLAN

In 2015, President Obama revised PAYE with a few new features and even broader eligibility.  REPAYE maintains the low discretionary income payment amount of 10%, but changed the forgiveness period for graduate loans to 25 years.  Undergrad loan forgiveness remains 20 years.

DIFFERING FEATURES

Now that you have a broad background on REPAYE vs PAYE, let’s take a look at the more nuanced differences between the two.

ELIGIBILITY

Eligibility to enter REPAYE and PAYE can be contingent on a few different factors.  These factors are based on the types of loans themselves, and the borrower’s circumstances.

New Borrower

A large reason we have so many income driven repayment plan options is centered around the new borrower rule.  When Congress revised IBR in 2010, they didn’t allocate enough money in the budget to cover the cost of implementing the revised features, so they delayed it by limiting access to the program.  The limiting mechanism was that student taking the loan must be a new borrower as of July 1, 2014.

A new borrower means that the student couldn’t have had a loan balance until after that date.  If the student had student loans prior to this date, they would be considered a new borrower if they had paid them off by then.

As previously mentioned, President Obama wanted to implement the revised IBR features sooner, so he used executive power to implement PAYE.  PAYE is nearly a carbon copy of revised IBR with two exceptions.  One of the exceptions was to lower the new borrower threshold to October 1, 2007, making it accessible sooner.  The other exception was to limit interest capitalization, discussed later.

When PAYE was revised in 2015, one of the revisions was to remove the new borrower limit altogether.  This is one of the key differences, however, this difference between REPAYE and PAYE become less and less significant with every year that passes.

The new borrower rule may make the decision for you when choosing between REPAYE and PAYE.  If you were NOT a new borrower as of October 1, 2007, PAYE wouldn’t even be an option.

There is one additional caveat about PAYE’s new borrower limit.  You must also have taken a loan distribution after October 1, 2011.  This won’t limit you, however, because if you haven’t received a distribution after then, you can easily perform a loan consolidation which counts as a distribution.

Financial Hardship

Financial hardship is another limitation based on the borrower.  In order to enter PAYE, you must show that you have a financial hardship.  To show financial hardship, you must calculate your monthly payment under both standard 10-year repayment and PAYE.  If the monthly payment under PAYE is less than the standard repayment, then you have a financial hardship.

REPAYE doesn’t require this, however, it’s not a very significant difference because there’s really no benefit to entering ANY income-driven repayment plan if it results in greater payments than under the standard 10-year repayment.

Types of Loans

Not only is eligibility determined based on the borrower, but also on the loans themselves.  Since the scope of this article is regarding REPAYE vs PAYE, there is no need to go into detail about the different types of loans because the rules are exactly the same between the two options.

ADJUSTED GROSS INCOME (AGI)

Both REPAYE and PAYE use 10% of discretionary income as the basis for calculating your monthly payment amount.  Discretionary income is derived by subtracting the poverty level applicable to you from your AGI.

Usually, this will result in the same dollar amount, but not always.  As your income increases, so will your payment amount.  If your income increases enough, 10% of your discretionary income will exceed the amount you would have been paying per month on a standard 10-year repayment plan.

With PAYE, payments are capped so that you will never pay more than the standard 10-year repayment amount.  REPAYE does NOT have this cap.  Let’s look at an example.

Pete is a single guy entering repayment with an AGI of $60,000.  His student loan debt is $100,000 at 8%.  Standard 10-year repayment would have him paying $1,213 per month or $14,559 per year.

This is a significant amount of Pete’s income, so he elects for REPAYE (calculated below).

Start with

AGI

$60,000

Subtract

Poverty Level

$12,060

Equals

Discretionary income

$47,940

Times 10%

Annual Payment

$4,794

Divided by 12

Monthly Payment

$400

 $400 per month is much more manageable now, but how much would Pete’s AGI have to increase before his income driven repayment plan exceeds the standard repayment plan of $1,213?  We’ll work in reverse.

Start with

Standard Monthly Payment

$1,213

Times 12

Annual Payment

$14,559

Divided by 10%

Discretionary income

$145,593

Add

Poverty Level

$12,060

Equals

AGI

$157,653

Here’s how it looks on a chart with increasing AGI.

REPAYE vs PAYE vs Standard payments based on increasing AGI

 To make things more complex in the REPAYE vs PAYE dilemma, the two plans treat married couple’s AGI differently.  PAYE looks at the borrower’s AGI only.  If you’re married and your spouse has a high income, you could file separately to keep your income driven repayment plan low.

REPAYE always includes your spouse’s income in the borrower’s AGI, even if you file separately.  Unless you’re already married and have a good idea of your spouse’s future income, it makes it very difficult to know how this rule will impact your future payments.

NEGATIVE AMORTIZATION

If your debt to income ratio is high enough, negative amortization will occur.  This is when your income driven repayment plan payment is less than the interest being accumulated.  So if your monthly payment is $300, but interest on your debt is $500, then you have $200 of negative amortization.

You do get some relief on subsidized loans for the first three years of repayment.  During this period the Department of Education will subsidize the negative amortization regardless of if you are in PAYE or REPAYE.

REPAYE takes it step further.  After the three year period, the Department of Education will continue to subsidize 50% of negative amortization.  Not only that but in REPAYE, you’ll also have your unsubsidized loans (which is likely the majority of your debt) negative amortization subsidized by 50% as well.

This is a big advantage when going for forgiveness because it reduces the amount of accumulated interest that will eventually be forgiven.  When your student debt is forgiven, it’s counted as ordinary income in the same year.  That will result in a VERY large tax bill, so reducing the ending balance is important.

CAPITALIZATION

With conventional loans, we’re used to interest compounding on regular intervals (daily, monthly, annually).  Federal student loans are different though.  Interest accumulates separately from the principal and is only added when capitalization triggers occur.

These triggers include the expiration of deferment or forbearance, leaving a repayment plan, failing to recertify, or no longer having a financial hardship (PAYE only).  When one of these occur, all accumulated interest is added the principal amount.

PAYE has a special feature that limits the amount of accumulated interest that can be added to the principal amount.  The limit is 10% of the principal amount when entering PAYE.  So if you enter PAYE with $100,000 in principal, then only $10,000 can be added to it.  To be clear, there is no limit to the amount of accumulated interest, just to the principal amount.

Like the negative amortization subsidy that REPAYE offers, this limit on principal capitalization PAYE offers can help reduce the ending balance that will be forgiven and result in a more manageable tax bill.

The most ideal option regarding capitalization, though, is to never trigger capitalization after entering repayment in the first place.

FORGIVENESS

For undergraduate loans, both REPAYE and PAYE have the same forgiveness period of 20 years.  Graduate loans are different under REPAYE.  The forgiveness period for graduate loans under PAYE is still 20 years, but under REPAYE the forgiveness period is 25 years.

The argument for extending the forgiveness period for graduate loans being that those borrowers don’t need as much help because they are likely better off.  This is probably true in most instances, but not all.

Regardless, if ANY of your loans are from graduate school, then all of your loans, including from undergraduate school, will take 25 years to forgive under REPAYE.  This results in sixty more payments and potentially a greater amount of accumulated interest to be taxed upon forgiveness.

REPAYE VS PAYE: A SUMMARY OF THE KEY DIFFERENCES

Use the following chart as a reference to remember the key differences when evaluating which income driven repayment plan is right for you.

Feature

REPAYE

PAYE

Eligibility

No financial hardship

No new borrower limit

Must show financial hardship and be new borrower on Oct 1, 2007

Payment Amount

10% discretionary income

10% discretionary income

Cap on Payment

No cap

Capped at standard 10 year

Married

Must include spouse in AGI

Can exclude spouse by filing separately

Negative Amortization

50% subsidy for both subsidized and unsubsidized loans

100% subsidy in first 3 years on negative amortization of subsidized loans

100% subsidy in first 3 years on negative amortization of subsidized loans

Capitalization limit

None, but no capitalization will occur if you stay in the plan and always recertify

10% limit added to principal.

Forgiveness

20 years if only undergrad loans

25 years if ANY grad loans

20 years

CONCLUSION

I wish I could give you a cut and dry answer to which plan is better when considering REPAYE vs PAYE.  However, there are a lot of important variables involved that can make your head spin if you try to juggle them all at once.  I’ll leave you with a few rules of thumb to help you out.

REPAYE makes more sense under the following circumstances:

  • You weren’t a new borrower as of October 1, 2007
  • When debt to income is high enough to cause negative amortization
  • Your income (or spouses) isn’t likely to increase substantially
  • All loans are from undergrad school

PAYE make more sense under the following circumstances

  • You were a new borrower as of October 1, 2007
  • When debt to income is NOT high enough to cause negative amortization
  • Your income (or spouses) IS likely to increase substantially
  • Any loans are from grad school

Finally, a quick word about public service loan forgiveness.  PSLF simplifies your decision for the following reasons:

  1. The forgiveness period is reduced to 10 years for both REPAYE and PAYE
  2. Forgiveness is tax-free, so you don’t need to worry about subsidies or capitalization to reduce your ending balance.

When going for PSLF, the only concern you have is to reduce your monthly payments, which gives PAYE an advantage due to the cap in payment amounts and ability to exclude your spouse’s income from the discretionary income calculation.