In the following article, we will discuss about IBR vs Pay As You Earn. Why should we discuss about these student loan payments? It is because student loan balances for recent grads average at more than $29,000, and unemployment and underemployment continue to plague many people. If you are struggling to make your student loan payments, you may want to consider switching your repayment plan.
Nowadays, Income-Driven Repayment (IDR) plans are very popular. IDR plans can adjust your student loan payments according to your income. There are two popular IDR plans, Income-Based Repayment (IBR) and Pay As You Earn (PAYE). Continue reading below for the differences between the two to see whether you should use IBR or PAYE.
About Income-Based Repayment (IBR)
IBR will adjust your student loan payments according to your income. If you have borrowed loans after the 1st of July 2014, you can get your monthly loan payments set at 10% of your discretionary income. However, if you have borrowed loans before that date, you will get your monthly loan payments set at 15% of your discretionary income.
In order to be accepted on IBR, you have to show that you are currently having a high debt-to-income ratio. Obviously, your current payments on the standard ten-year plan must be higher than the 10% or 15% of your discretionary income. If IBR actually helps to lower your payments, there is already a big chance that you will qualify for it.
In addition to lowering your payments, IBR also extends your payment period. On IBR, you will be switched to a 20-year or 25-year repayment term. After the repayment period ends, if you still owe some money on the student loans, the remaining balance will be forgiven by the government so that you will no longer be required to pay the loan. However, you will need to pay income taxes on the forgiven amount.
IBR is available for most federal loans. However, there are some loans that don’t qualify for IBR. Loans that can’t qualify for IBR are private loans and specific loans that are made to parents.
About Pay As You Earn (PAYE)
The differences between IBR vs Pay As You Earn include the payment percentage, repayment period, and requirements. Nevertheless, just like IBR, Pay As You Earn can lower your student loan payments based according to your income.
Pay As You Earn caps the payments at 10% of your discretionary income. In addition, it extends the repayment period to 20 years. If you still have any remaining balance after the period, the remaining balance will be forgiven. As you can see, it can reduce your payments and erase your debt more than IBR.
However, it is harder to qualify for PAYE. In order to qualify, you need to be a new borrower as of the 1st of October 2007. In addition, you also must have taken out a Direct Loan after the 1st of October 2011. You cannot qualify for PAYE if you have a balance on a FFEL Program loan or Direct Loan which originates before October 2007.
PAYE covers most federal loans just like IBR, but similarly includes private loans and certain loans that are made to parents such as FFEL PLUS and Direct Plus. However, unlike IBR, PAYE obliges you to consolidate certain loans before switching.
Payment Reduction and Loan Forgiveness
As mentioned above, there is a possibility on IBR that your payments will be set at 10% if you have gotten student loans after July 1, 2014. However, if you already have gotten student loans before that date, IBR will set your payments at 15%.
If you have student loans from before July 1, 2014, PAYE is the better choice as it caps the payments at 10%. So, in this case, it will lower your monthly payments better. In addition, it also offers earlier loan forgiveness than IBR so that you can get out of student debt more quickly. But don’t forget that a forgiven loan is considered as a taxable income, so you will get hit by a bigger tax bill.
Both IBR vs Pay As You Earn have interest benefits for subsidized loans, but PAYE’s is better. You see, if the interest which accrues your subsidized loans is bigger than your payments, the government will pay back the difference. This benefit lasts for three years since the day you start repaying under IBR or PAYE.
However, the difference between IBR vs Pay As You Earn comes down to the amount of interest that can be capitalized. IBR doesn’t limit the amount of interest that can be capitalized. On the other hand, on PAYE, if you are no longer qualified to make income-driven payments, the unpaid interest that can be capitalized is limited to 10% of the loan balance.
Although PAYE can give better overall benefits, it is not suitable for everyone. It is harder to qualify for PAYE because there are more requirements that you must meet. In order to be accepted, you need to become a new borrower as of October 1, 2007 and you must have disbursed your Direct Loans after October 1, 2011. In addition, PAYE also requires certain loans to be consolidated: subsidized and unsubsidized loans from the FFEL program, FFEL PLUS loans, and FFEL Consolidation Loans.
On the other hand, IBR does not have complex qualification requirement. It does not require you to consolidate other loans. However, note that both IBR and PAYE require you to consolidate the Perkins Loans program, which has actually expired in September 2017.
|IBR||Pay as You Earn|
|- Payment is 10% or 15% of your discretionary income||- Payment is 10% of your discretionary income|
|- Payment period is 20 years or 25 years||- Payment period is 20 years|
|- Possibly lower income tax on the forgiven loan||- Possibly higher income tax on the forgiven loan|
|- Easier to qualify||- More difficult to qualify|
In general, Pay As You Earn (PAYE) is indeed the best choice. It can lower your monthly payments more than IBR, and it can also offer loan forgiveness more quickly. However, qualifying for PAYE can be quite a challenge. In addition, don’t forget that the shorter payment period may translate into a bigger income tax. If you can’t qualify for PAYE or you don’t want to deal with the hurdle, IBR makes the way to go. Even though the payment reduction is not as great, IBR is much easier to qualify.