Episode Transcript
Brenton: In July of this year, borrowers currently eligible for the Pay as You Earn plan will make the permanent decision of whether to stay on that plan or to shift to the updated version of Revised Pay as You Earn. In this episode, we talk about how to know which option may be the best option for your federal student loans. Let's get started.
Brenton: Hello, this is Brenton Harrison of Escape Student Loan Debt, and your host for the Escape Student Loan Debt podcast. Welcome into the final episode on the journey from foundational elements of Income Driven Repayment plans to the updates that we've seen take place for Revised Pay As You Earn. And now in this episode, we are finally going to discuss the merits of Pay As You Earn as compared to the updated version of Revised Pay As You Earn.
So we are going to take that terminology, those [00:01:00] foundational elements of Income Driven Repayment plans. And we're going to go line item by line item and compare how they're impacted under each of these plans. So that you can build your knowledge base as you decide, which option is best for your student debt. We're going to start with eligibility.
We've covered in the past that for the old and new version of Revised Pay, As You Earn, there are no date based requirements as to who can participate. As long as you are paying your loans back using a direct loan, it cannot be an FFEL or a Stafford loan, you can participate in either plan. Conversely Pay As You Earn has not just loan type requirements, but also date-based eligibility. For this particular plan, that date based eligibility says that you have either taken out your first loan or you did not have a previous loan balance as of October 1st, 2007. And you also have to have taken out another loan after October 1st, [00:02:00] 2011. It's a two part eligibility requirement. And if you have those dates in place and also have direct loans, you can participate in Pay As You Earn.
Next, the repayment period. And this is a huge one that differentiates the two options. For Pay as You Earn the repayment period is 20 years. And compared to the previous version of Revised Pay As You Earn, which required you to pay for 20 years for undergrad loans, 25 years if you had graduate school loans, this was a really attractive feature of Pay as You Earn. You have five years less on your repayment schedule, regardless of when you took out that debt and many borrowers in the past have gone to Pay as You Earn in an effort to get that debt out of the way faster if they have graduate school loans. Now with Revised Pay As You Earn those rules have been tweaked a little bit.
If you have undergraduate loans, only the majority of borrowers will see their loans forgiven after 20 years of repayment. But there's actually a sub component of this category that's [00:03:00] really important because if you owe less than $12,000 in undergraduate loans, that debt can be forgiven after 10 years of payments, instead of 20. For every thousand dollars increment over $12,000, it adds a year onto your repayment up to a cap of 20 years for undergraduate loans. As an example, if you have $15,000 worth of debt, that is $3,000 above the $12,000 barrier. So you would add three years onto that 10-year repayment and your loans will be forgiven after 13 years of payments. Conversely, if you have graduate loans, just like it worked before, you have to pay your loans for 25 years before any remaining debts are forgiven in full.
Next. What is the percentage of your Discretionary Income that has to be paid towards these debts? This is another major tweak towards the updated version of Revised Pay as You Earn. Prior to these changes, the percentage of Discretionary Income was the same for both [00:04:00] plans. The calculation for the formula was adjusted gross income, minus 150% of the federal poverty level. And both Pay As You Earn and Revised Pay as You Earn required you to pay 10% of whatever number resulted as a payment each year. The first area where you see these changes is the percentage of the number that has to be paid. Because while Pay, As You Earn remains at 10% of Discretionary Income, the updated version of Revised Pay, As You Earn again, breaks your loans down based on the type of schooling you used it to pay for.
If you have undergraduate loans, only you pay 5% of your Discretionary Income towards your debt each year. If you have graduate school loans only you pay 10% of your Discretionary Income towards your loans each year. And if you have a combination of the two, you'll pay a weighted average of those two numbers based on the composition of your loans.
This is a monumental change specifically for those who have undergraduate school loans only, or community college only. Really anything short [00:05:00] of undergrad, because based on not just this, but also the calculation of Discretionary Income people in this scenario will see their student loan payments cut by more than 50% in most cases.
And before I give you an example, I will give you the specifics of what I mean by the calculation of Discretionary Income. Because while with Pay As You Earn, the formula has not changed. It is adjusted gross income minus 150% of the federal poverty level, for the updated version of Revised Pay. As You Earn it has changed.
It is now the adjusted gross income minus 225% of the federal poverty level, a monumental increase that allows you to shield more of your income from the calculation of your student loan payment. If you combine these two factors for undergraduate borrowers, where they immediately see their payment go from 10% of Discretionary Income to 5% and also allow them to take more money off of the table, it leads to that [00:06:00] 50% plus decrease in payments that I just referenced.
As an example, if we take a family of four that has an adjusted gross income of a hundred thousand dollars, if they pay back their student debt using Pay As You Earn, they would have a monthly payment of $458.
However, if we take that same family of four with an adjusted gross income of a hundred thousand dollars and put them on the updated version of Revised Pay As You Earn, it would knock their payment from $458 all the way down to a little over $135 a month. That is a decrease of over $300 a month, primarily because of that lower payment at 5% of Discretionary Income, but also the ability to take 225% of the federal poverty level out of the equation as compared to 150% of that number as seen in Pay As You Earn.
[00:07:00]
Brenton: Another major update to Revised Pay as You Earn is found in its interest subsidy. If you look at Pay, As You Earn the interest subsidy covers 50% of all unpaid interest for [00:08:00] three years only. Conversely, the updated version of Revised Pay As You Earn will now cover 100% of all unpaid interest in all years.
We've talked about the fact that currently any loans forgiven under Income Driven Repayment plans do not lead to any income taxation. But that allowance will sunset at the end of 2025. And if it isn't extended by Congress before that date, that means that from 2026 and beyond, any forgiven debts would it be taxable to you as income in the year of forgiveness.
So, if you look at Pay As You Earn, where you can have an unlimited amount of interest that's growing on your loans, and then look at Revised Pay As You Earn, where you can be assured that you will not owe more than you took out in student debt.
That can play a major role in your decision because if your payment never reaches the point where it's enough to pay the interest growing on your debt, Pay As You Earn could lead to a monumental tax bill, whereas with Revised Pay As You Earn, you would [00:09:00] know exactly how much is forgiven at maximum, because you know that you can't owe more than you took out in student loan debt.
Next let's get into some smaller tactical details as to how you structure your payments under these options. And we'll touch first on the Married Filing Separately exclusion. As a refresher, under certain student loan payment plans, when you look at the formula for Discretionary Income, borrowers who are married to spouses who earn a significant level of Pay, have often wanted to make sure that that's taken off the table before their payment is calculated, especially if their spouse does not have student loan debt of their own. As an example of I earned $50,000 a year and I have federal student loan debt and my wife earns $200,000 a year and does not have student loan debt and isn't on an income driven repayment plan. The last thing I would likely want is her $200,000 bringing up my Discretionary Income, thus bringing up my student loan payment.
Prior to these updates in Pay [00:10:00] As You Earn, if you filed your taxes, Married Filing Separately, you could take your spouse's income off the equation, but you could also continue to use them as a person in your household. As an example, if you are married and have two kids and you file Married Filing Separately, your spouse's income wouldn't be included, but you would still have four people in your household when finding your federal poverty level. So you were really getting to play both sides of the fence. You get to take their income off, but you still get to increase your federal poverty level by having them in the household.
With the new version of Revised Pay as You Earn, you can file your taxes separately to remove their income, but in doing so you also have to remove them from your household when it comes to finding your federal poverty level. And it's not just for Revised Pay as You Earn, they're instituting this new form of calculation for Pay As You Earn as well. So these will now work in the exact same way where the spouse's income can be removed, but they also are removed from federal poverty level.
Another reason that extremely high income [00:11:00] earners would gravitate towards Pay As You Earn in the past is because it has a 10 year standard payment cap. What that means is that every single year, when your loan service are asked to calculate your Discretionary Income, they would compare what you would pay under an Income Driven plan to what you would pay under a 10 year standard plan.
If your IDR payment was higher than that 10-year standard plan, they would simply make you pay the 10 year standard plan rate, but they would continue giving credits towards your years of forgiveness. And if in future years it made more financial sense for you to go back to the IDR payment, they would switch you back to that payment, but you would never lose track of that 20 years of credit that it took towards forgiveness.
Revised Pay As You Earn in the old and the updated version, have no such payment cap. So if you have an extremely high income and it turns out that what you would pay under this plan is significantly more than what you would pay under a 10-year standard plan. [00:12:00] There is no mechanism to lower your payment. You would be required to pay whatever that payment dictates on a monthly basis.
And this payment cap can come into play sooner than you think. As an example, let's say that we have a person who owes $40,000 in student debt at 6% interest. Well, if they were to pay that loan back using a 10-year standard plan, their payment would be about $444 a month. If you look at what they would have to earn to have that payment cap come into play, it's not even a hundred thousand dollars of household income.
So if you have a two income household that earns more than about $98,000, the Pay As You Earn plan would not even allow them to pay that payment based on Discretionary Income. They would instead say the payment that you make under this option is more than the standard plan. So we will give you credit towards your 20 years of repayment, but we will instead make you pay the standard plan payment.
Now let's take it to Revised Pay As You Earn. And let's [00:13:00] assume that this couple instead makes $300,000 a year. Well, when you calculate the payment under these new guidelines, their payment is almost $2,000 a month. So if they stuck with this payment, that $40,000 that they owe it wouldn't be forgiven. It would be paid off in less than three years if they chose this option.
But because there is no payment cap, they would have to pay that option to stay on the plan. They would not be bumped down to that $444 option that you find on the standard plan.
I'll be transparent. That took a lot longer than I thought. And my goal is to make sure that we keep these episodes to 15 minutes or less. I don't think I can do that in cover the rest that we need to cover when comparing these two options. So bear with me one more time. We'll push the rest out to part two of Pay As You Earn versus Revised Pay As You Earn. And in that episode, we will cover the reasons that one might choose a certain plan over the other. See you soon.
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