Federal ONE IBR vs PAYE & REPAYE

With several federal programs available to student loan borrowers looking for help with repayment, it’s important to know how each option stacks up against the others. You might have heard of Income-Based Repayment (IBR), Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE) plans.

And there has, at times, been momentum in the House of Representatives for passing the Prosper Act, which would usher in a new Federal ONE IBR program. What are the differences between each program and how do you determine which is right for you? Here’s what you need to know.

With PAYE and REPAYE, you generally only have to put 10% of your discretionary income toward repaying your student loans.

PAYE is an income-based repayment plan that allows student loan forgiveness after 20 years, whereas REPAYE carries an interest subsidy that PAYE does not have and takes five years longer to receive forgiveness if your loans were for graduate study; otherwise, for undergraduate loans, the repayment period is 20 years.

With the Prosper Act’s creation of Federal ONE loans, you would only need to pay the principal and interest that would be due under the Standard 10-Year plan. You would have to pay 15% of your discretionary income on the Federal ONE IBR repayment plan, but once you hit that cumulative dollar total, you would owe nothing in taxes. Under the Prosper Act, if it were passed, the PSLF program would be repealed.

I’ve built one of the only student loan income-based repayment calculators out there that can model the effects of the Prosper Act, so let’s use it to do some hypothetical case studies for some of the occupations I see with large debt loads.

Our assumptions when comparing Federal ONE vs. Direct Loans

In the following hypothetical examples, I assume a 7% interest rate for the federal student debt and 3% increases in salary for the folks we’re modeling. I’m guessing that incomes would remain independent of loan policy.

Medical professionals can borrow up to $235,500, while other graduate programs have a lower cap of $150,000 in aggregate borrowing. I’m using the option of refinancing to a 10-year 4.5% interest rate as an alternative baseline to compare against.

Another big assumption is that schools would only charge the maximum borrowing limit for the cost of education, which could be wildly incorrect if they can convince the private sector to start originating loans to cover the difference in revenues.

Finally, because I encourage all my clients to max out their retirement accounts, we’ll assume everyone is saving $18,500 a year in their 401(k) or 403(b) on a pre-tax basis, which lowers their student loan payments. With each example, we’re pretending that our single borrower could choose between the PAYE, REPAYE and Federal ONE IBR plans.

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Example 1: More debt than income

Let’s use, for this example, a character named Wendy who is a veterinarian who graduated from the University of Pennsylvania and has way more debt than income. I currently see Penn alumni veterinarians come out with around $390,000 in student loans if their education was financed completely with student debt. Wendy works for Banfield Pet Hospital making $70,000 a year.

Let’s look at the cost of PAYE and REPAYE versus Federal ONE IBR. I’m going to assume that the vet school would be limited to charging the $235,500 maximum.

Check out the costs below:

Remember that your payments on REPAYE and PAYE have little connection to your actual debt with the Federal Direct Loan program.

That means the actual payments on the Prosper Act would be the highest. But notice when the debt would be forgiven  — in 2051!

In contrast, PAYE and REPAYE would let Wendy pay about $90,000 and $120,000 respectively, but she’d have to pay a monster tax bomb in the future.

It’s clear that refinancing her student loans would be a suboptimal decision regardless of whether Wendy had Direct or Federal ONE loans.

It’s difficult to look at the total cost column and make judgments without thinking about the cost of each path in today’s dollars. After all, these repayment periods are over different terms, and we need to adjust for alternatives where you could invest your money.

That’s why the relevant takeaway when looking at this chart is the cost in today’s dollars.

Prosper actually gives a similar cost to the REPAYE program, with the big difference that Prosper takes much longer to repay.

Example 2: Slim chance of repayment

For this example, I am using the character Jim, who is an associate chiropractor. Most chiropractors come out of school burdened by a ton of debt, with incomes that are not all that different from what they could’ve made as a non-specialized college graduate.

Perhaps this is due to the proliferation of chiropractors coming from private schools that charge a ridiculously high amount of tuition for the value of the degree.

Are there plenty of exceptions? Of course. I’m simply speaking in the aggregate.

Pretend Jim graduates from Palmer College of Chiropractic and decides to be an associate for another doctor long term. He brings in $55,000 a year.

He’d probably leave school with about $275,000 of loans on the Direct Loan program. I expect he’d get saddled with the max $235,500 under the Federal ONE program, as no private lender is going to give extra funds to cover the revenue loss the chiropractic college would take.

This is what the cost looks like:

That’s not a typo. If Jim maxes out his retirement account, he could set up his loans to last until 2101. Unless there are some major medical advances, under the Federal ONE program he would likely die with the debt.

Another crazy thing to say is that the Prosper Act would actually be vastly superior to the REPAYE and PAYE programs. By allowing Jim to pay his loans back over an extremely long period, the cost of the Federal ONE IBR option is only $39,000 in today’s dollars because of the time value of money.

REPAYE and PAYE would result in Jim having to pay a big tax bomb.

With Federal ONE IBR, Jim would effectively be taxed an extra 15% for the rest of his life. Obviously, you’d prefer to avoid that, but if you can game the system to have a very low income, then you face minimal costs under this new plan. 

Example 3: Planning on Public Service Loan Forgiveness 

For this example let’s use the fictional story of Christine, a doctor who is planning on pursuing Public Service Loan Forgiveness (PSLF). Perhaps the biggest victims of the Prosper Act would be future physicians not currently in medical school (those who are already borrowing would be grandfathered in).

We’ll assume that Christine is an OB/GYN resident who just graduated and will have an attending salary of $220,000. She works for a nonprofit hospital and qualifies for PSLF. We’re pretending that she’s eligible for both programs to show what the impact would be on Christine’s finances.

Let’s assume under the Direct Loan program that she owes $400,000 from attending the University of New England College of Osteopathic Medicine. The Prosper Act would result in her owing the max of $235,500.

We’ll assume under both scenarios that she has built up four years’ of credit toward forgiveness during residency. We’re not going to model PAYE and REPAYE separately, as her choice would be between PSLF, refinancing and the Federal ONE IBR plan.

Look at the massive difference between PSLF and the next cheapest option, private refinancing. It’s clear to me that higher-income professionals under the Prosper Act would be pushed heavily toward refinancing.

There are tens of thousands, if not hundreds of thousands, of physicians who would become clients of the student loan refinancing companies under the Prosper Act.

Medical school in today’s dollars would cost Christine about $140,000 more under the Prosper Act. Although many of the issues surrounding physician burnout are not financial in nature, the higher cost of becoming a doctor would probably be detrimental to attracting more individuals to the profession.

Example 4: High-income earners

For this example, I’m creating a character named Josh who lives large in the big city.

Although Big Law salaries increase at a rate much faster than 3%, let’s just assume for sake of simplicity that Josh the Big Law attorney went to the University of Virginia and is making $180,000 right now in New York City with inflation-level raises. He would’ve left school with about $250,000 of student debt under the Direct loan program.

Under Federal ONE, law schools would have a lower borrowing limit of $150,000. I suspect the lower-tier schools would ask students to borrow close to this maximum and the top-tier programs would turn to the private market to capture some of the revenue loss they’d experience.

Just looking at the expected Federal loan balance gives us the result below:

This is showing an unambiguous benefit of the Prosper Act for borrowers who have high expected incomes. The borrowing caps imposed on grad schools will force the more expensive ones to limit their tuition to what the government will lend.

In the case where schools are able to charge more, it will be because the private sector is willing to come in and lend to students because of their high future incomes.

Under the PAYE and REPAYE options, Josh would have to pay back loans over a long period and still have a tax bomb to deal with. That’s not attractive on his $180,000 income.

Rather, the lower tuition cost that Prosper would give him would allow him to achieve a cost of law school of only $153,000 in today’s dollars.

The Prosper Act’s Federal ONE IBR is also much cheaper in this scenario, but it’s not as good as refinancing.

Who would lose big in the legal world under this scenario? Public interest and government attorneys.

Winners and losers under the Federal ONE IBR Program

By eliminating the tax bomb when the government forgives loans, the Prosper Act’s Federal ONE IBR Program would be much better for borrowers with incomes below $70,000.

For borrowers with incomes above $150,000, the Prosper Act would also be better because it would force down graduate school tuition and would allow for an easier time refinancing as the market gets even more competitive with more business to fight over.

For borrowers in the middle of that income range, however, the difference would likely be a wash.

The big exception is that borrowers currently set up to benefit under the PSLF program would lose a ton of money if the Prosper Act passes.

Academic hospital physicians, teachers, college professors, state prosecutors, and zoo veterinarians are just a few examples of the people who would face huge financial losses.

By many estimations, as much as 25% of the workforce could qualify for PSLF for their loans. Because the 75% that might benefit from the Prosper Act are likely unaware of how it could help them, I expect the 25% of borrowers who could qualify for PSLF would care a lot more and perhaps win this legislative battle.

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