How Do Student Loan Repayment Plans Differ?
Let's Try to Understand How You May Benefit From IBR, PAYE, REPAYE, and Your Other Student Loan Repayment Options
About the author: Kevin Mahoney, CFP® is a fee-only financial advisor in Washington, D.C. Kevin's work with his clients focuses on paying off student loans, buying a house, investing savings, and budgeting. Kevin is the founder & CEO of Illumint, a virtual financial planning firm specifically designed to help couples and young families with their financial decisions.
Almost all student loan borrowers -- whether it's immediately after graduation or 10 years into full-time employment -- reach at point at which they become very focused on paying off their student loans in the most efficient manner that their budget can manage. With at least eight different student loan repayment options, however, the decisions required to create an appropriate plan are far from straightforward. As Donna Rosato wrote for Consumer Reports:
"It's tempting to simply opt for the plan that gives you the lowest monthly payment. But that may not be the best choice for the long term because you'll end up paying more in interest on your loan.
Instead, look for the plan that lets you pay the lowest total amount based on monthly payments you can afford. Be realistic about what you can handle now so you won't fall behind. You can always step up payments later. 'The path to the right plan is different for everybody,' Betsy Mayotte, president of The Institute of Student Loan Advisors, says."
With that in mind, let's attempt to understand the differences between the most common student loan repayment plans: the 10-Year Standard Repayment Plan, the Income-Based Repayment (IBR) Plan, the Pay As You Earn (PAYE) Repayment Plan, and the Revised Pay As You Earn (REPAYE) Repayment Plan.
10-Year STANDARD REPAYMENT PLAN
"If you don’t specifically choose another plan, you’ll automatically be placed in the Standard Repayment Plan, and there you’ll stay until and unless you decide to switch, writes Meredith Simonds for Student Loan Hero. "The Standard Plan is designed to pay off your loans in 120 payments over 10 years.
While the monthly payments on this plan may well be higher than with other options, paying off your loan in 10 years will lower the overall interest you pay, compared with some of the alternatives."
According to the Federal Student Aid website, the following loans are eligible for the 10-year Standard Repayment Plan:
Direct Subsidized Loans
Direct Unsubsidized Loans
Direct PLUS Loans
Direct Consolidation Loans
Subsidized Federal Stafford Loans
Unsubsidized Federal Stafford Loans
FFEL PLUS Loans
FFEL Consolidation Loans
The site adds that, "Under this plan, your monthly payments are a fixed amount of at least $50 each month and made for up to 10 years for all loan types except Direct Consolidation Loans and FFEL Consolidation Loans."
InCOME-BASED REPAYMENT (IBR) PLAN
When you start to consider alternatives to the 10-year Standard Repayment Plan, be careful not to confuse the several income-driven repayment options with one (similarly named) such option, the Income-Based Repayment Plan, or IBR. The phrase "income-driven" describes multiple repayment plans that revolve around your income level, whereas "income-based" is one specific type of plan. Even if you've got that down, though, you'll need to keep in mind that there are two versions of IBR, one created in 2009 and one created in 2014.
As Mark Kantrowitz explains at Saving for College, the 2009 version of "Income-based repayment (IBR) is an income-driven repayment plan that bases student loan payments on 15 percent of the borrower’s discretionary income. The remaining debt is forgiven after 300 payments (25 years). Generally, borrowers whose debt at graduation exceeds their annual income will have a reduced monthly payment under IBR.
IBR is available for both loans in the Federal Family Education Loan Program (FFELP), otherwise known as the guaranteed student loan program, and the Direct Loan program. It is the only income-driven repayment plan that is available in both federal loan programs."
The more recent, 2014 version of IBR "does the same thing as PAYE [described below], according to The Student Debt Lawyer. This repayment plan option "lowers [the monthly payment] from 15% to 10% [of discretionary income], and forgives any remaining balance after 20 years, but is only good for a borrower with no balance prior to July 2014. That’s why I say PAYE is for the class of 2017, because many members of the class of ’15, ’16, and ’17 will have loans prior to July 2014. The class of 2018 and beyond will likely have no loans before July 2014, if we are talking about undergraduates."
"The biggest disadvantage for the Income-Based Repayment plan is that if you have several years where your income is extremely low, your monthly loan payments may not be enough to cover the interest due and you experience 'negative' amortization.
In that case, the balance owed on your loan actually goes up.
Why should that matter if you will have it all forgiven after 20 or 25 years? Because current IRS rules say you must pay taxes on the amount forgiven."
PAY AS YOU EARN (PAYE) REPAYMENT PLAN
The Obama administration created the Pay As You Earn (PAYE) Repayment Plan in 2011 in an attempt to offer student loan borrowers greater debt relief than the plans available at the time offered.
Here are the basics: PAYE enables you to pay as little as 10% of your discretionary income towards your federal student loans and forgives any remaining balance after 20 years of monthly payments.
As "The College Investor" Robert Farrington writes in a detailed PAYE summary, "To qualify for the PAYE program you need to have borrowed your first federal student loan after October 1, 2007. If the loan you took out was a Direct or Direct Consolidation loan, you need to have taken it out on or after October 1, 2011. Additionally, the payment you make under PAYE based on your income and family size needs to be lower than what you pay under the Standard Loan Repayment program. This is to make sure you are not receiving a benefit that your income-to-debt ratio does not qualify for. He notes that there is no maximum income limit for qualifying for PAYE: "the program does not take into account how much you earn as a raw number, but how much you earn in relation to your federal student loan debt."
REVISED PAY AS YOU EARN (REPAYE) REPAYMENT PLAN
Given the existence of the PAYE repayment plan, doesn't another plan called Revised Pay As You Earn (REPAYE) just create unnecessary confusion? Yes, but as The Student Loan Sherpa explains, the plan creators had some good intentions:
"The problem with PAYE was that only recent student loan borrowers were eligible to sign up. If any of your student loans were too old, IBR was your best option. That meant 15% of your income [to calculate monthly payments] instead of 10%. Many borrowers cried foul, arguing that this treatment was unfair. If two people have the same income, why should one person pay $150 per month while the other only has to pay $100? REPAYE was created to fill this gap."
He notes, though, that despite what you might expect, the two repayment plans are not identical.
Over at Nerd Wallet, Ryan Lane writes:
"The biggest difference with Revised Pay As You Earn is its interest subsidy. Because income-driven payments are often low — they can be as small as $0 — they may only chip away at the accruing interest on your loans. Interest accumulates fast that way, so most income-driven plans subsidize the difference between your payments and the accruing interest at certain points in repayment.
REPAYE has a more generous subsidy than other income-driven plans, paying the entire difference on subsidized loans and half the difference on unsubsidized loans for the first three years. After that, it covers half the difference on both loan types.
For example, let’s say you owe $20,000 in subsidized loans and $80,000 in unsubsidized loans, with both having 5% interest rates. Each month, your subsidized loans would accrue $84 in interest and your unsubsidized loans would accrue $336. If you qualified for $0 payments, the government would pay that entire $84 and half the $336, or $168, for the first three years under REPAYE. After that, your subsidy would be $42 and $168."
These repayment plan options are confusing enough to make your head spin for weeks, but if you're not fatigued yet, you can find some more student loan terminology to work on here. Or you can just start preparing now for whatever new student loan repayment plan the next U.S. president will introduce.