Revised Pay As You Earn (REPAYE) is one of the many income-driven repayment plan options offered by the U.S. Department of Education to help manage student loan payments.1 While REPAYE is useful in keeping payments low and maximizing federal student loan forgiveness, there are some aspects to the program we should discuss because they could get people into serious trouble.
Here’s what you should know about this program — the good, the bad, and the ugly.
- REPAYE Plan Background
- REPAYE Eligibility
- What are REPAYE payments like?
- Pros to REPAYE
- Cons to REPAYE
- Last Thoughts on REPAYE
Revised Pay As You Earn (REPAYE) Guide
One thing you’ll learn about our government is that they don’t like updating or removing older repayment plans that won’t work anymore. Instead, they continually add new ones which confuses borrowers.
As the cost of college started to increase beyond the ability for most parents to pay, so did student debt —and with that, the student’s ability to make payments on that debt. This problem gave way for the creation of the Graduated repayment plan, then eventually income-driven repayment plans like Income Contingent Repayment (ICR) and Income-Based Repayment (IBR).
However, the addition of those repayment plans acted more like a bandage rather than fixing the outlying problem: college costs are out of control. Because of that, monthly payments on income-driven repayment plans like IBR are still unaffordable. That’s when the U.S. Department of Education added the Pay As You Earn (PAYE) repayment option. However, PAYE came with rigorous eligibility requirements and very few borrowers actually benefited from this repayment option.
The U.S. Department of Education’s response? They introduced a new and expanded version of PAYE, called Revised Pay As You Earn or “REPAYE”. REPAYE eliminated the “new borrower” loan disbursement provision that made PAYE so inaccessible to borrowers. But the plan also came with many new regulations that make REPAYE very unique from PAYE, IBR, and even ICR.
Today, any student borrower with federal Direct Loans, which includes Direct Stafford loans, Direct Consolidation loans, and Direct Graduate PLUS loans are eligible to choose REPAYE as a repayment option. That makes the program very accessible to many borrowers.
Unfortunately, older student loans like Federal Family Education Loans (FFEL) don’t qualify. However, FFEL loans can get consolidated into a Direct Consolidation Loan, which does qualify.
Also, REPAYE is not available to parents with Direct Parent PLUS loans. The only income-driven repayment option available for Parent PLUS loans is the Income Contingent Repayment (ICR) plan.
Eligible Loans: Direct Loans (Subsidized and Unsubsidized), Direct Graduate PLUS loans, Direct Consolidation loans.
REPAYE Repayment & Term
Revised Pay As You Earn (REPAYE) is genuinely an advantageous repayment plan for many seeking to maximize loan forgiveness or simply lower payments. The program caps your payments at 10 percent of your “discretionary income,” which I’ll explain below.
Depending on your student loans, REPAYE has two possible repayment terms.
- Undergraduate Loans: Loans taken out for undergraduate studies have a repayment term of 20 years, with any remaining balance forgiven at that time.
- Graduate/Professional Loans: Loans taken out for graduate or professional studies have a repayment term of 25 years, with any remaining balance forgiven at that time.
It’s important to note that any forgiveness achieved through completing the term of REPAYE (20-25 years) is taxed as income in the year it was received. If forgiveness is likely, you should evaluate what that tax liability might look like.
Planning today for that tax bill will help you avoid negative consequences associated with owing the IRS money.
Pros to REPAYE
Revised Pay As You Earn (REPAYE) is genuinely an advantageous repayment plan for many seeking to maximize loan forgiveness or simply lower payments. But like I mentioned earlier, it does take some planning and analytics for things to work out the way you hope.
Here are a few pros to choosing REPAYE:
- 10% AGI payments. To calculate your monthly payment, REPAYE uses 10% of your “discretionary income.” The discretionary income formula takes your Adjusted Gross Income and subtracts one-and-a-half times the poverty line. You can find the 2020 Poverty Guidelines in the U.S. Department of Health & Human Services’ website.2
- 50% Unpaid-Interest Subsidy. REPAYE comes with a very robust interest subsidy which is great news considering that subsidized Stafford loans for medical students no longer exist.
Here’s how the interest subsidy works. Half of the interest that you don’t pay with the 10% payment is waived and does not accrue interest. That’s a huge perk of the program and residents currently on PAYE should crunch some numbers to see how much they benefit before switching to REPAYE. This perk can effectively reduce your interest rate.
Here’s an example:
Loan: $200,000 at 6.8%
REPAYE payment as a resident making $50,000: $260/month
Annual interest accrued: $13,600
Annual interest paid: $3,240
Annual interest unpaid: $10,360
Amount forgiven: $5,180
Effective interest rate: 4.2%
- Ability to earn forgiveness outside of PSLF. All income-driven repayment plans come with a long-term loan forgiveness provision, which is taxable.
Attending a private college or university and medical school can make this interest subsidy beneficial for a really long time. Of course, like Income-Based Repayment (IBR) and Pay As You Earn (PAYE), the unpaid interest you have on any subsidized student loans is still completely covered for 3 years.
Cons to REPAYE
While REPAYE offers some excellent benefits, especially for single people, there are some substantial downsides that we should consider. While REPAYE may work well for us today, it might not in near future.
Let’s take a look at some of these downside for pitfalls to avoid:
- Marriage penalty. REPAYE closed the Married, Filing Separately (MFS) loophole available in other income driven repayment (IDR) plans like IBR or PAYE. With other IDR plans, you could file separately from your spouse if their income didn’t add any value to your repayment strategy. Filing separately allows your monthly payment to be calculated solely on your income, thereby lowering your monthly payment. This was extremely helpful to doctors with higher earning spouses who didn’t have student debt, especially lower-earning residents. In short, if you’re on REPAYE while married, it doesn’t matter how you file your taxes; your spouse’s income will be added regardless.
- Elimination of Payment Cap. All other income-driven repayment plans like IBR and PAYE have a ceiling as to how high your monthly payments can go. Your monthly payments would never be higher than that of Standard repayment. REPAYE doesn’t have that payment cap. Your monthly payments will be 10% of your discretionary income; the more discretionary income you have, the higher your monthly payments will be.
- Negative amortization. Interest accrual under REPAYE can be a bit unnerving. It’s not uncommon for monthly payments to be lower than the interest accrued each month, which causes what’s called, “negative amortization. Negative amortization occurs when your monthly payment doesn’t cover the interest accrued. This will create an “outstanding interest” balance that will continue to grow until the interest is capitalized (added to your balance).
Do you see how the Outstanding Interest and Total Outstanding (balance) columns continue to rise, despite paying $1,339 a month?
If you plan on earning forgiveness through PSLF, I can see how this might not concern you. Just keep in mind that PSLF has a very high rejection rate (90.9%).
In the March 2020 PSLF Report provided by the U.S. Department of Education, 188,396 PSLF applications were submitted in 2020. 171,321 of those PSLF applications were rejected.
- A potential tax liability. With forgiveness through PSLF, it doesn’t matter how high your loan balance gets. The forgiven amount is a hundred percent tax-free. However, the same cannot be said for forgiveness through an income-driven repayment plan like REPAYE. Loans forgiven through that method will be taxed as income in the year that they’re forgiven. Having a growing student loan balance (due to negative amortization) will only increase that looming tax bill.
Forgiven amount: $150,000
Tax bracket: 30%
Tax liability: $45,000
Who you owe the money to: IRS
A lot of borrowers might expect to see this bill right around the time they prepare to send their first child off to college. Not a good time.
My last thoughts
Today, it might appear as if you can switch repayment plans as needed. But the same might not be true in just a few years. You might find that your income reaches a threshold where you are no longer eligible to switch back to an Income-Based Repayment (IBR) plan.
Don’t forget; borrowers must be able to demonstrate financial need in order to switch to IBR. While that’s not hard for a recent graduate, what happens in a few years when their income multiplies?
On IBR, your monthly payments would never exceed that of payments on the 10-year Standard repayment plan. Unfortunately, there’s no such cap with Revised Pay As You Earn (REPAYE).
On REPAYE, payments are solely tied to 10 percent of your discretionary income, which means the higher your income, the larger your monthly payments become. In addition, as smaller, individual loan tranches get paid off (if you’ve never consolidated), discretionary income frees up causing monthly payments to increase.
As a result, your monthly payment schedule could rapidly accelerate, dramatically reducing or even eliminating any potential to benefit from forgiveness.
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There comes the point in everyone’s student loan journey where they have to question the effectiveness of their student loan payoff strategy. Obviously, there’s a lot on the line.
Perhaps you’ve been making payments for some time now but not seeing your balance go down as fast as you’d like —or worse, your balance is actually increasing.
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1) U.S. Department of Education, — https://studentaid.gov/manage-loans/repayment/plans/income-driven
2) U.S. Department of Health & Human Services, 2020 Poverty Guidelines —https://aspe.hhs.gov/2020-poverty-guidelines
3) U.S. Department of Education, Public Service Loan Forgiveness Data — https://studentaid.gov/data-center/student/loan-forgiveness/pslf-data