Compton Advisors, LLC: Pay As You Earn - Temporary Relief for Student Loan Debt

For many recent graduates, student loan debts may seem insurmountable. According to the Federal Reserve Bank of St. Louis, over 30% of borrowers in payment status (i.e. not currently being deferred) are at least a month behind on their payments. Some borrowers may benefit from the Department of Education's Pay As You Earn (PAYE) program

WHAT IS IT?

One of the Education Department's three income-driven repayment programs, this programs sets an upper bound on monthly loan payments.

HOW DOES IT WORK?

As the name implies, your payment obligation under this program is tied to your family income and size. Specifically, your monthly payment is expected to be 10% of your discretionary family income (as determined by the Department based on your family's earnings and size. Link to the calculator here). In no case, however, would the payment amount exceed the amount calculated under the Standard 10-year Repayment Plan.

FORGIVENESS

At the end of 20 years (or less in the case of qualifying occupations), any remaining balance is forgiven. There are two catches to this forgiveness: first, you must make all your payments in a timely manner. Second, any amounts forgiven will be treated as income by the IRS, just like ordinary debt forgiveness. On the plus side, months that you are in economic hardship deferral count as on-time payment months.

The occupations that qualify for forgiveness after 10 years (technically, 120 qualifying months) are public service jobs as defined by the Education Department:

Qualifying employment is any employment with a federal, state, or local government agency, entity, or organization or a not-for-profit organization that has been designated as tax-exempt by the Internal Revenue Service (IRS) under Section 501(c)(3) of the Internal Revenue Code (IRC). The type or nature of employment with the organization does not matter for PSLF purposes. Additionally, the type of services that these public service organizations provide does not matter for PSLF purposes.

A private not-for-profit employer that is not a tax-exempt organization under Section 501(c)(3) of the IRC may be a qualifying public service organization if it provides certain specified public services. These services include emergency management, military service, public safety, or law enforcement services; public health services; public education or public library services; school library and other school-based services; public interest law services; early childhood education; public service for individuals with disabilities and the elderly. The organization must not be a labor union or a partisan political organization.

Additionally, only Direct Loans are eligible for forgiveness under the 10-year option.

ELIGIBILITY

Only new borrowers as of October 1, 2007 are eligible. Additionally, you must have received a disbursement after October 1, 2011. Also, your income situation must be such that Pay As You Earn payments are less that the Standard payments - usually this means the initial debt is more than your family income.

Private loans are not eligible nor are Parent PLUS loans. Unconsolidated Direct loans and PLUS loans to graduate or professional students are always eligible if they meet the criteria above. Stafford loans are eligible only if they have been part of a one-time loan consolidation. Consolidation loans that include Parent PLUS loans are not eligible.

CONCLUSIONS

Obviously, lower payments in a situation where you are facing many other expenses are welcome in the short run and loan forgiveness, even if you have to pay taxes on it, may save you money. On the other hand, the longer you stretch out the payments, the longer interest continues to accrue on larger balances. Without forgiveness, and even sometimes with, you could end up paying far more in total than you would have under the Standard repayment plan.

PAYE is just another tool for you to use in managing your finances. If it's the right one for you, it could bring you welcome relief.