How the Pay As You Earn (PAYE) plan works
Editor's Note: As of March 26, 2025, the Pay As You Earn (PAYE) repayment plan is open once again for new applicants. For more details, visit: https://studentaid.gov/announcements-events/idr-court-actions
Millions of Americans search for flexible options to manage their student loan payments each year. The Pay As You Earn (PAYE) repayment plan stands out for its tailored approach, adjusting monthly payments based on your income and family size. Whether you are facing a large debt from graduate school or have a relatively modest balance, understanding how PAYE works can help you make informed decisions about your financial future. Below, we unpack PAYE eligibility, calculations, benefits, risks, and the steps required to enroll, offering a clear roadmap for anyone considering an Income-Driven Repayment plan.
What Is the Pay As You Earn Repayment Plan?
The PAYE repayment plan is an income-driven repayment option for federal student loan borrowers. It was designed to make student loan payments more manageable by tying your monthly payment amount to your income and family size, rather than the size of your debt. For many, PAYE offers a practical way to keep payments affordable, even when facing substantial balances after graduation.
Who Is Eligible for PAYE?
Not every borrower qualifies for PAYE. Before you apply, review these criteria to see if you’re eligible:
Loan Type: Only federal Direct Loans are eligible. Private loans never qualify for PAYE. Loans made under the Federal Family Education Loan (FFEL) or Perkins Loan programs may become eligible under certain circumstances if consolidated into a Direct Consolidation Loan.
Date of Loan: You must have taken your first federal Direct Loan on or after October 1, 2007, and received a disbursement of a Direct Loan on or after October 1, 2011.
Partial Financial Hardship: You must demonstrate a "partial financial hardship." This means that your calculated PAYE payment would be less than what you would pay on a 10-year Standard Repayment Plan, based on your calculated discretionary income.
Loan Status: Loans must not be in default, grace period, or in school status.
Taking the time to verify your loan details in your Federal Student Aid account can help you confirm your eligibility quickly.
How Monthly Payments Are Calculated Under PAYE
The core of PAYE is its income-driven formula. Here’s how your payments are set:
Determine Discretionary Income: Discretionary income is the difference between your Adjusted Gross Income and 150% of the federal poverty guideline for your family size.
Calculate Payment: Your monthly payment is generally capped at 10% of your discretionary income, divided by 12 months.
Annual Certification: You must recertify your income and family size every year your IDR Anniversary date. Payments will be recalculated annually based on the latest income data.
Remaining Loan Balance After 20 Years on PAYE
At the end of the 20-year repayment term under the Pay As You Earn (PAYE) plan, any remaining loan balance may be classified as taxable income for that year. This could result in a significant tax bill when you file your return. To avoid surprises, it's important to plan ahead and consult with a Certified Student Loan Professional. They can help you understand the potential tax implications and prepare for any future financial obligations. Planning now can ensure you’re ready for what lies ahead.
Example Scenario
Let’s take a look at Alexa Parker’s situation:
Alexa has $300,000 in federal DIRECT student loans with an average 7% interest rate and earns $150,000 annually as a W-2 employee. She also contributes 10% of her salary to her 401(k) through her workplace.
Here’s how her repayment under the PAYE plan is calculated:
The 2025 federal poverty guideline for a single individual is approximately $15,650. At 150% of this guideline, the amount is $23,475.
Alexa’s Adjusted Gross Income (AGI) is likely around $135,000, calculated as $150,000 minus her 10% 401(k) contribution.
Using this, her discretionary income is about $111,525 ($135,000 - $23,475).
Under the PAYE plan, 10% of her discretionary income amounts to $11,152 annually or roughly $930 per month.
If Alexa’s income or family size changes, her payment will be recalculated during her next Income-Driven Repayment (IDR) anniversary.
At Alexa's current income, her payment is covering about 53% of the interest that accrues each month. If her income doesn't increase substantially, then her balance will grow.
Under the PAYE plan, Alexa Parker will need to make payments for a total of 20 years, or 240 months. After completing these payments, any remaining balance on her student loans will probably be taxed. So for someone like Alexa, who likely will have a significant remaining balance, we're talking about a substantial tax bill.
To prepare for this financial obligation, it is crucial for Alexa to start saving ahead of time. By estimating the potential tax liability now, she can proactively set aside funds over the course of the repayment term. Alexa could start an investment account tailored to medium-term goals to grow her contributions over the next 20 years. Consistently contributing even a modest amount monthly can help her avoid financial stress later on. Certified Student Loan Professionals (CSLPs) often encourage planning for such scenarios early, as it ensures financial preparedness and reduces the burden at the end of the repayment period.
Key Benefits of Choosing the PAYE Plan
PAYE isn’t the right solution for everyone, but its benefits can be significant:
Lower Payments During Lean Years: Payments stay affordable, especially early in your career when your income may be below average.
Interest Subsidy: If your monthly payment doesn’t cover all the interest, the government will pay the unpaid interest on subsidized loans for up to three years.
Potential for Forgiveness: After making 20 years of qualifying payments, any remaining balance is forgiven.
Protection from High Debt: Your monthly payment is capped based on income, not loan balance. Someone with $50,000 in loans and someone with $300,000 in loans pay the same if their incomes and family sizes are identical.
Adjustment for Life Changes: Payments adjust when your income or family size changes, helping manage new jobs, layoffs, or family additions.
Important Risks and Tradeoffs of PAYE You Need to Know
Like any loan repayment option, PAYE comes with a few things to consider:
Payments are income-driven, not balance-driven: Your payments are determined by your income, meaning the more you earn, the more you pay. If your earnings are high enough to pay off the loan balance before the 20-year term ends, it might be more practical to settle the remaining balance early.
Remaining Balance is Taxable: Unless Congress or a future President decides otherwise, any remaining loan balance at the end of year 20 under the repayment plan is currently considered ordinary taxable income.
Annual Recertification is Essential: Failing to complete your annual income recertification on time can result in removal from PAYE, shifting your payments to the Standard 10-Year Plan. While you can reapply for PAYE and retain the progress you've already made, staying on top of recertification deadlines is crucial to avoid disruptions.
Married Borrowers Face Added Complexity: If you are legally married and file your tax return Married Filing Jointly, then your spouse’s income is considered, which may increase payments. If filing Married Filing Separately, your spouse's income is not considered.
Not Open to All Loans: While most borrowers who meet the loan originate date criteria (no outstanding federal loan balance prior to October 1, 2007) have Direct loans and qualify, it's worth noting that Direct Parent Plus loans are not eligible for PAYE.
How to Enroll in the PAYE Repayment Plan
If you think PAYE fits your situation, follow these steps to enroll:
Start the Income-Driven Repayment Plan Request: Login in through www.studentaid.gov/idr and start the application process online. You can also apply via mail with a paper application and supporting income documentation.
Share demographic details: Be prepared to verify your contact information, marital status, and any dependents you support financially.
Submit Income Documentation: Provide proof of income, either by approving the Department of Education to pull necessary information from your IRS tax return or uploading alternative documentation of income.
Select PAYE: Specify PAYE as your preferred plan; you can evaluate estimated payment amounts for all available income-driven repayment plans in the request form.
Wait for Confirmation: Your loan servicer will review your application and notify you of your new payment amount.
Renew Annually: While your loan servicer is supposed to remind you, it's smart to mark your calendar to submit updated income and family size info each year to stay on PAYE.
Finding Your Best Repayment Option
Deciding which student loan repayment plan makes sense for you is rarely simple. The Pay As You Earn plan is a powerful option for borrowers who want a payment tied to their income, especially if your debt is high relative to what you earn. Focusing on eligibility, understanding the benefits and risks, and following the right enrollment steps can empower you to manage your student loans with clarity and confidence.
If you’re unsure whether PAYE is right for you, use the Federal Student Aid Repayment Estimator or consult with a Certified Student Loan Professional. You can hit the easy button by hiring us to help you figure it out. For more details, explore the official Federal Student Aid website www.studentaid.gov or reach out to your loan servicer.