You might have heard about the Department of Education’s overhaul of income-driven repayment plans (IDR) for federal student loans. This includes a new IDR plan — Saving on a Valuable Education (SAVE), which really just modifies the existing Revised Pay As You Earn (REPAYE) plan. As part of the Biden administration’s attempt to simplify income-driven repayment options and make SAVE the default “IDR repayment plan” for student loan borrowers going forward, it will block enrollment to the Pay As You Earn repayment plan (PAYE) after July 2024.
This brings up several questions for borrowers who are currently on PAYE. Note that if you're currently on PAYE, you can remain on PAYE. You don’t need to do anything to sign up or affirm that you wish to remain on PAYE.
However, in the future, you must be very careful about leaving the PAYE plan, because then it won’t be possible to get back on it.
Major changes with SAVE (formerly REPAYE)
Before discussing the reasons why you might want to stay on PAYE, let’s review the changes to REPAYE (now called SAVE). Previously, PAYE and REPAYE had a very similar payment calculation. Borrowers could deduct 150% of the poverty line, based on his/her family size, from his/her adjusted gross income. Then, 10% of his/her remaining discretionary income is his/her annual student loan payment.
However, the Biden Administration increased the deduction based on federal poverty guidelines to 225% for SAVE. Additionally, beginning in July 2024, monthly federal student loan payments will be 5% of borrowers’ discretionary income for undergrad-only borrowers, 10% for grad-only borrowers, and a weighted average of those numbers if you have debt from both undergraduate and graduate school.
SAVE will also waive 100% of unpaid interest whenever a borrower’s calculated payment is not enough to cover all of the annual interest. Additionally, SAVE now allows borrowers to file income taxes as “married, filing separately” and exclude spousal income from the payment calculation.
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Reasons to stay on PAYE
Despite the positive changes that came with the new SAVE plan, the Biden administration intends to maintain the 25-year repayment period for graduate loans. The main reason a borrower might want to stay on PAYE is for the ability to maintain a 20-year repayment period until loan forgiveness.
Shorter repayment term
Although SAVE offers most borrowers a lower required payment, the additional five years of payments vastly outweighs the benefit of the lower payment amount. That last handful of repayment years are likely peak-earning years and thus, are the largest payments during the term.
Let’s take the example of a borrower who owes $400,000, and with a current income of $150,000. They expects to get large raises over the next several years, bringing their income up to $300,000. Because they plan to stay single, their monthly student loan payment is only about $100 lower on SAVE compared to PAYE. However, their average monthly payment over the last five years on SAVE would be $3,500.
Due to SAVE’s interest subsidy and the last five years of payments, the remaining balance would be about $300,000 after 25 years. If they stayed on PAYE, their student loan balance would increase to almost $500,000 at the end of the 20 years because of the accrued unpaid interest. This would create a larger tax bomb.
However, PAYE would save almost $100,000 compared to SAVE all-in-all, because of the five fewer years of payments, and they can enjoy the freedom of being student debt-free five years sooner.
The SAVE plan doesn't have a payment cap based on the 10-Year Standard Repayment Plan amount. So, the second reason to stay on PAYE is maintaining access to a payment cap. Take a physician who signed up for PAYE during residency. He could have low monthly payments while building credit toward 20-year loan forgiveness or 10-year Public Service Loan Forgiveness (PSLF).
The payment cap was established when he joined PAYE, and when he starts his attending career, his monthly payment can never eclipse that capped payment amount, no matter his future income. If he left PAYE to get a lower monthly payment amount on the new REPAYE plan, he would lose that payment cap. As a result, his monthly payment might skyrocket while he is an attending physician, leaving no loan balance left to forgive at the end.
Before switching to the new SAVE plan
First, it is worth pointing out that if you are on PAYE and you borrowed your loans on or after July 1, 2014, and you decide to leave PAYE, you still have access to the Income-Based Repayment (IBR) plan for new borrowers.
That plan is almost identical to PAYE. PAYE has one small advantage over IBR, a limit on the capitalization of interest if you don’t have a partial financial hardship — which is why we never recommended the IBR plan for new borrowers.
IBR was established by federal law, so changing it requires a majority vote in the House and 60 Senate votes. This makes it much more difficult to remove or change. On the other hand, the Obama administration established PAYE and REPAYE plans by executive order.
Those who borrowed on or after July 1, 2014 will most likely retain the ability to choose between SAVE and the benefits of PAYE via IBR in the future. If anyone who borrowed before July 2014 leaves PAYE after July 2024, they would forever forfeit access to PAYE’s benefits. It is crucial that you weigh this decision carefully.
If you are concerned about potential legal challenges to the new SAVE plan, that’s a good reason to remain on PAYE for now and wait for the dust to settle.
Even with these new benefits for SAVE, switching requires recertifying your income right now. Because borrowers were not required to recertify income during the pandemic, a lot of people will have much lower payments based on past income. Currently, borrowers aren’t required to update with their current student loan repayment plans until 2024 or 2025.
Even if the apples-to-apples math shows that SAVE results in a lower payment than PAYE, you might save money by waiting to switch plans and delay income recertification for as long as possible.
When it makes sense to switch to the new SAVE plan
It’s possible that someone currently on PAYE could save money by switching to the new SAVE plan. Those with larger family sizes and a larger percentage of total debt coming from undergraduate loans could enjoy the largest payment decreases.
Let’s say the borrower in our first example has the same income and a loan balance of $300,000, $50,000 of which is from undergraduate years. He or she is married with three kids and chose the PAYE plan, in order to exclude his or her spouse’s income via filing taxes as “married, filing separately.”
This ability used to be PAYE’s biggest advantage over SAVE for many married borrowers, but the new SAVE plan allows the same option for tax filing. The larger poverty line deduction with SAVE makes a much bigger impact for borrowers with larger family sizes.
In our sample scenario, the borrower would pay less than 10% of his/her discretionary income, due to his/her unpaid undergraduate loan balance. As a result, he/she would save almost $500 a month on SAVE. But the 100% subsidy for unpaid interest would prevent his/her balance from growing, keeping the tax bomb close to what it would be if he/she stayed on PAYE.
As a whole, he/she would save about $70,000 by switching to SAVE, a potentially worthwhile student loan forgiveness delay of five years.
What should borrowers on PAYE do next?
Those on PAYE who received their disbursement of federal student loan debt before July 1, 2014 should keep in mind that they can switch to the SAVE repayment program later, but there’s no going back. In contrast, those who borrowed their loans on or after July 1, 2014 can still choose between SAVE and IBR for new borrowers, which is virtually identical to PAYE.
Either way, there’s no rush to make this decision. You have time to wait for the dust to settle, legally and politically. Subscribe to our email list to get access to the latest Student Loan Calculator updated with the new SAVE rules and receive weekly email updates that include the latest student loan news. You can also meet with us to find out the best income-driven plan for your situation, and get advice or guidelines on filing your tax return jointly versus separately from your spouse.
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