For most borrowers who experience partial financial hardship and took out Direct Federal loans after 2007, the PAYE (Paye As You Earn) Repayment plan and IBR (Income Based Repayment) Repayment plan are options to consider to lower your monthly payment. You might see the same monthly payment and forgiveness estimate for each of these plans, but there are a few differences.
If you took out loans before 2014, you would be eligible for the Original IBR repayment plan and PAYE. This IBR plan bases monthly payments using 15% of your discretionary income and has a repayment period of 25 years. Generally in this case, the PAYE plan will be a better option as it will only use 10% of your discretionary income for repayment calculations and has a repayment period of 20 years for undergraduate loans and 25 years for graduate loans.
If you took out loans after 2014, you would be eligible for the New IBR repayment plan and PAYE. This IBR plan bases monthly payments using 10% of your discretionary income and has a repayment period of 2 years for undergraduate loans and 25 years for graduate loans, the same as PAYE. Under both of these plans, payments are capped at what you would pay if you were in the 10 year Standard plan. If your income increases and you are no longer eligible for a lower monthly payment vs the 10 year Standard monthly payment, you would still remain in either of these plans, paying the Standard monthly payment payment. There is one major difference with these plans: how interest capitalizes.
- For the New IBR plan, there is no cap to how much interest can capitalize. This means you can experience interest capitalizing each month and ballooning over time.
- For the PAYE plan, your capitalized interest is limited to 10% of your existing loan balance. The prevents interest from ballooning over time.
This means borrowers will see less interest capitalize on their loans in the PAYE plan. Both of these plans are eligible for PSLF and IDR Forgiveness. If you are pursuing PSLF, your entire remaining balance including any unpaid interest, will be forgiven.