Pay As You Earn, or PAYE, was introduced three years ago and heralded as the next big thing in student loan repayment plans, where the monthly payment amount was based on the borrower’s income—generally known as income driven repayment. Not long afterward, concerns were raised about PAYE’s efficacy, including the limited number of borrowers who were eligible.
In President Obama’s June 9 White House memo, he directed Secretary of Education Arne Duncan to “propose regulations that will allow additional students who borrowed Federal Direct loans to cap payments at 10% of their income.”
The result is REPAYE—Revised Pay As Your Earn, rolled out on October 27 and likely to be implemented next month. These additions to the alphabet soup of student loan acronyms are also called PAYER and REPAYER. Like the plans themselves, it’s added to the confusion.
Now critics say that REPAYE includes features that PAYE doesn't have--features that can be a disadvantage to borrowers. Among them are a marriage penalty and the lack of a monthly payment cap. The result may be that ED has reinvented a wheel that wobbles more than it did before.
"PAYE restricts eligibility to borrowers who have no loans prior to October 1, 2007 and who have at least one loan on or after October1, 2011," said Mark Kantrowitz, an authority on student loan finance. "President Obama wanted to eliminate the restrictions on PAYE eligibility. Somehow the financial restrictions were disregarded in the new REPAYE plan, which will cost $15 billion over ten years.”
Both PAYE and REPAYE forgive Federal loans after 20 years, but under REPAYE, graduate and professional school borrowers have to wait 25 years for loan forgiveness.
REPAYE’s lack of a payment cap means that borrowers could watch their monthly payments rise as their income rises. Depending on how much their income goes up, it can start to defeat the purpose of an income-contingent repayment plan.
The repayment cap also has links to REPAYE’s marriage penalty.
“REPAYE has a marriage penalty, basing the payment on a couple’s combined income while under PAYE, married borrowers who file separate returns can have payment based only on the borrower’s income,” Kantrowitz said. He noted that this would be moot for people who pay off their loans before they tie the knot.
But it’s an example of the Obama plan’s short-sightedness; many people are still stuck with student loans by the time they marry. This may also be an incentive for people to forgo marriage who would otherwise take the plunge. Ironically, the White House has publicly fretted about Millennials who skip marriage because of their student loans.
In general, Kantrowitz thought eligible borrowers were better off with PAYE—which will probably reduce the number of people who will get with the REPAYE program.
”This calls into question the Obama administration's estimate that 5 million borrowers will benefit from REPAYE, since new borrowers are eligible for and will choose PAYE. There are only about 2.6 million borrowers in IBR, and less than half of them are likely to switch to REPAYER.
“Moreover,” said Kantrowitz, “anybody who is eligible for REPAYER is also eligible for income-based repayment (IBR),” said Kantrowitz. People in IBR would be likely to stay there. Many new borrowers will chose IBR over the REPAYE plan, the White House publicity campaign notwithstanding.
Honey Smith, in her November 10 blog post on Get Rich Slowly also identified problems with the marriage penalty.
”Under REPAYE, both spouses’ income and federal student loan debt is considered when determining the monthly payment, regardless of whether they file federal tax returns jointly or separately,” she said. “So if, for example, only one spouse has student loan debt and/or one spouse is a high earner, REPAYE might not result in the lowest monthly payment.”
However, spouses filing separately can’t take the student loan interest reduction. This is valuable, Smith said, “because it is an above-the-line deduction, meaning that you can take it in addition to the standard deduction even if you don’t itemize on your tax return. So if you had been filing separately to qualify for IBR and you and/or your spouse’s payments would be lower under REPAYE, you can probably file jointly and get the student loan interest deduction as well."
”Under both IBR and PAYE, the monthly payment is capped at what it would have been under the standard repayment plan,” added Smith. “REPAYE doesn’t have a monthly maximum payment, so if your income takes off, you could wind up paying more per month than you would under the standard plan. And if you switch from REPAYE to another plan to avoid that outcome, any outstanding interest will be capitalized.”
A payment calculator for PAYE already exists. Kantrowitz thought a REPAYE calculator would not be difficult to implement. But the devil will be in details that will be unknown until borrowers can get a handle on their future income, which will be largely guesswork.
“The issue is that with an individual borrower, the only way to tell whether REPAYE or IBR is better is to evaluate it for their particular situation,” said Kantrowitz, which may go beyond the functionality of a REPAYE calculator. “What if your income jumped five years into repayment? What if you get married three years into repayment? What if your spouse earns $30,000 a year? $75,000 a year? $150,000 a year?” Or goes through periods of instability?
Kantrowitz thinks that REPAYE will be temporary. "Most likely all four income-driven repayment plans will be replaced with a single repayment plan as part of reauthorization of the Higher Education Act. (HEA)," he said. Passed in 1965, the HEA is the font of all Federal student aid and is set for reauthorization--a process that will drag on into next year.
Given the Republican control of Congress, Kantrowitz said the result will most likely look a lot like the current Income-Based Repayment plan. “Borrowers in the ICR, IBR, PAYE and REPAYE plans will be grandfathered in, but all new borrowers in income-driven repayment plans will have only one option,” he said. That would be the one replacing the current craze in student loan refinancing.