Do you have big student loans, a lower income, or both? If so, you've probably seen the acronyms IBR and PAYE tossed around as you look for ways to make your budget work without defaulting on your debt.
Both IBR and PAYE are income-driven repayment plans. This means they can offer lower monthly payments and, eventually, loan forgiveness to people that meet their standards. We’ve mentioned them on multiple occasions.
But what are the similarities and key differences between these income-driven repayment plans? In this post, we provide a head-to-head comparison of IBR vs. PAYE to explain exactly what these programs are, where they come from, and how they can help you manage your student debt.
What Is “Discretionary Income”?
Both IBR and PAYE rely on “discretionary income” to calculate your payment. So it’s worth understanding what this is before we get into how the programs work.
“Discretionary income” has a technical definition under federal education law. The government will calculate it for you when you apply for any income-driven repayment plans. But you can estimate it now:
- 1Calculate your adjusted gross income (AGI). That’s the money you pay federal taxes on, as distinct from your total gross income.
- 2Find the federal poverty guidelines for your location and family size and multiply that number by 1.5.
- 3Subtract #2 from #1 to find your annual discretionary income, then divide by 12 for your monthly discretionary income.
Basically, the government thinks some level of income should not be available for student loan repayment. Whereas anything you make above that line is fair game. Check out our discretionary income calculator >>>
IBR: Everything You Need To Know
“IBR” stands for “Income-Based Repayment." Sometimes people talk about “IBR” casually to mean all types of income-driven repayment plans. But it’s actually a specific federal program for certain types of borrowers.
IBR has been around since 2007 when President George W. Bush signed a big overhaul of federal financial aid practices. It was one of the first of a group of programs that recognized the reality that some people take out a lot of debt in anticipation of an income they just can’t get.
There’s almost no way to discharge student debt in bankruptcy. But these repayment plans at least offer some kind of way forward for borrowers who have federal (but not private) student loans.
IBR: Who And What Loans Are Eligible?
The federal government maintains a big guide to all the various income-driven repayment plans. As always, make sure to check the source to see if anything’s changed! But as of right now, you can apply for IBR if:
Note that Parent PLUS loan borrowers are kind of screwed by this program (as well as by PAYE below.) It’s generally a lot easier for a former student to get loan relief. So be really careful about taking out loans if you’re a parent, especially if you don’t feel like your income is secure.
IBR: How Payments Are Calculated
IBR payments are calculated based on 10 or 15% of your discretionary income. And payments recalculate every year based on updated information you provide about your income and family size.
Whether your payment is 10% or 15% of your discretionary income depends on when you took the loan out. If you took it out after July 1, 2014, you’re in luck. If you have an older loan and qualify for PAYE you’ll be in better shape there (see below).
If your 10% to 15% payment doesn’t cover the interest on your loans, they will keep growing. Let’s say you can only afford $100 a month (10% of your discretionary income) and your loan accumulates $200 of interest a month. That leaves you with $100/month of what’s called “excess interest.”
For subsidized loans, IBR will forgive all of that unpaid interest for the first three years. After that, there is no interest subsidy. If your income grows to the point where you leave the program, excess interest will be capitalized.
IBR: How To Apply
You can apply for IBR through the Department of Education at this link. (Note: you have to submit a separate application for each loan servicer, if you have more than one!) This application actually is good for all the income-driven repayment plans, including IBR. You can ask for a specific program or allow your student loan servicer to determine what you’re eligible for.
You’ll need to submit information about your family size, location, and adjusted gross income so that the government can calculate your payment. If your AGI is pretty close to what’s been on your recent federal tax returns, this will be an easy process. But if you’re applying because of a recent job loss or income drop, you’ll need to provide some alternative documentation, like pay stubs.
IBR: Payoff And Loan Forgiveness
If you miss the deadline, accrued interest will be capitalized (VERY BAD). Your monthly payment will revert to what it would be under the standard 10-year plan. So seriously, don’t miss the deadline.
However, if you start IBR today, and keep making your payments for 20 or 25 years (for loans made before July 1, 2014), any remaining balance will be forgiven. The only caveat is that you may have to pay income taxes on any forgiven debt.
PAYE: Everything You Need To Know
“PAYE” stands for “Pay As You Earn.” It’s been around since 2012 and was signed into law as part of another big student loan reform under President Obama.
While you’re in the program, your monthly payments will be a maximum of 10% of your discretionary income. Below, we look at each of the same factors as above to make it easier to directly compare IBR vs. PAYE.
PAYE: Who And What Loans Are Eligible?
When you compare the eligibility standards of IBR vs. PAYE, you'll find that PAYE is more strict. As of writing, here are the requirements:
Once again, careful before you take out a Parent PLUS loan for your kids. You won't be able to join PAYE or IBR either. The only income-driven repayment that you can qualify for as a Parent Plus borrower is the (much less attractive) Income-Contingent Repayment (ICR) plan. And you won't even qualify to join ICR until after you've consolidated your loans into a Direct Consolidation Loan.
PAYE: How Payments Are Calculated
Your monthly payment will be 10% of your discretionary income. As with IBR, if this payment doesn’t cover the interest on your loans, unpaid interest will accumulate. And, like IBR, PAYE will cover all of the excess interest on subsidized loans for the first three years.
PAYE is unique, though, in how it handles unpaid interest if your income grows to the point where you no longer qualify to make income-based payments. In this case, the maximum that can be capitalized is 10% of your original balance.
It's important to note, however, that this benefit only applies if you stay on the PAYE plan. If you leave the plan (for any reason), there is no limit to the amount of unpaid interest that can be capitalized.
PAYE: How To Apply
You can apply for PAYE at this link. (Note: you have to submit a separate application for each loan servicer, if you have more than one!) This application actually is good for all the student loan income driven programs, including IBR; you can ask for a specific program or allow your student loan servicer to determine what you’re eligible for.
You’ll need to submit information about your family size, location, and adjusted gross income so that the government can calculate your payment. If your AGI is pretty close to what’s been on your recent federal tax returns, this will be an easy process. If you’re applying because of recent job loss or income drop, however, you’ll need to provide some alternative documentation, like pay stubs
PAYE: Payoff And Loan Forgiveness
As with IBR, you have to recertify your income and family size every year. Do not miss the deadline. If you do, accrued interest capitalize. Plus, your payment will be reset to what it would be under the standard 10-year repayment plan. Very not good! Keeping up with these plans’ paperwork is key.
The good news is that if you still have debt left after 20 years of PAYE payments, it will be forgiven. This is another one of the big pluses of PAYE in the IBR vs. PAYE comparison. While borrowers with older loans may have to wait for 25 years to earn forgiveness on IBR, all PAYE participants receive 20-year terms.
What About REPAYE?
In this article, we've focused our comparisons on IBR vs. PAYE. But these aren't the only income-driven repayment plans available today. In addition to ICR (which should really only be used by Parent PLUS borrowers), there's the Revised Pay As You Earn (REPAYE) plan.
REPAYE was instituted in 2015. It expanded the PAYE program to borrowers that didn’t meet some qualifications for original-flavor PAYE. First, PAYE required you to be a fairly recent borrower. But anyone can qualify for REPAYE, even if you took out your loans in the 1990s or 2000s (or even earlier).
Also, REPAYE could be a good choice if your income is a little higher. You can only get into IBR or PAYE if your payments would be lower than they'd be on the standard 10-year plan.
With REPAYE, you can be eligible even if you’re not at that point. This might be beneficial if you anticipate your family size increasing or your income dropping. You can start the 20-year clock on making REPAYE payments now instead of waiting. And your payment will always still be capped at 10% of discretionary income.
REPAYE differs in a few other ways from IBR and PAYE:
For most people, PAYE is probably a better deal if you qualify. But, if you don’t, REPAYE might be a better option than IBR.
Are There Downsides To Income-Driven Repayment Plans?
Unfortunately, yes. Income-driven repayment plans can be great options if you have a lot of debt relative to your income. But you should know that there are downsides.
First, you'll end up paying more over time than you would if you just paid off your loans in ten years (or less). This is because you’ll be paying for 20 or 25 years. So even with a lower payment per month, it’s going to add up.
Second, as of right now, you may have to pay income taxes on any debt that’s forgiven. That could be a HUGE problem if your debt keeps growing over time and what ends up getting forgiven is tens to hundreds of thousands of dollars. This is a long way in the future for most borrowers. But it’s good to be aware of it and keep up to date with the latest student loan legislation.
Third, relative to standard payment plans, income-driven repayment plans are just more of a pain. They require a lot more paperwork to get started. And you have to keep recertifying and providing new information every year.
None of these downsides should stop you from pursuing IBR or PAYE if you qualify. These programs can be lifesavers if you simply can’t afford the standard payments. But if you can make standard payments, those are probably a better option to avoid these downsides.
IBR vs. PAYE: Final Thoughts
If you're struggling with huge loans and a low income, the PAYE or IBR income-driven repayment plans could massively reduce the amount you have to come up with each month.
They won’t solve all your problems. And even 10% of your discretionary income might end up feeling like a lot. But they can prevent you from ruining your credit. And they do provide a path forward to forgiveness even though it's pretty far in the future.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.