PAYE vs. IBR: Which Income-Driven Plan Is Better for You?

If you struggle to afford your monthly student loan bill, consider applying for an income-driven repayment plan, such as Pay As You Earn (PAYE) or Income-Based Repayment (IBR). Both plans adjust your payments based on your income and family size.

Here’s what you need to know when choosing between PAYE vs. IBR and how to pick the best income-driven repayment plan for your financial situation.

PAYE vs. IBR at a glance

PAYE and IBR are among four options for an income-driven repayment (IDR) plan — the other two are Income-Contingent Repayment and the Saving on a Valuable Education (SAVE) plan.

All four IDRs are solid options that can reduce your monthly student loan payment based on your income (and your spouse’s income, if applicable). In this article, we’ll focus on PAYE and IBR, as well as how each differs.

Before comparing them, there are a couple of key things to note. First, the payment and terms for IBR depend on whether your loan was issued before or after July 1, 2014. Also, be aware that the Department of Education is set to end new enrollments for PAYE as it rolls out the new SAVE plan.

Here’s an overview at Pay As You Earn versus Income-Based Repayment:

PAYE covers most federal loans but excludes private student loans and federal loans made to parents, such as Parent PLUS loans and PLUS loans from the Federal Family Education Loan (FFEL) program.

That said, however, all PLUS loans are eligible for PAYE if transferred into a Direct consolidation loan first.

You’ll typically qualify for IBR if you have a high debt-to-income (DTI) ratio, such as if your federal student loan debt exceeds your annual discretionary income or represents a large percentage of your yearly income.

As with PAYE, most federal student loans are eligible for IBR. However, parent and private student loans don’t qualify for IBR.

What is discretionary income?

Your PAYE and IBR payments are calculated based on your discretionary income. Here’s how to estimate it for yourself:

1. Determine your adjusted gross income (AGI) — your tax return will have this info.
2. Refer to the annual poverty guideline for your family size and location, then multiply this number by 1.5.
3. Take the number from Step 1 and subtract it from Step 2 to determine your discretionary income. Use this amount to determine your potential income-driven repayment rate.

PAYE vs. IBR in detail

Here are the key differences between Pay as You Earn vs. Income Based Repayment:

PAYE may lower your student loan bills more than IBR (for older loans)

PAYE might give your budget more breathing room than IBR if your student loans were issued before July 1, 2014. PAYE caps your student loan bill at 10% of your discretionary income, while IBR payments for older loans are set at 15%.

For loans dated on or after July 1, 2014, payments will cap at 10% of your income for both PAYE and IBR plans.

PAYE offers loan forgiveness up to five years earlier than IBR

As illustrated above, both plans offer student loan forgiveness if you have a balance at the end of your repayment term. However, the PAYE repayment plan allows you to release your debt five years earlier than the IBR plan.

• PAYE borrowers qualify for forgiveness after 20 years of payments.
• IBR borrowers with student debt predating July 2014 will be on the hook for 25 years. Otherwise, it’s 20 years, as with PAYE.

Be aware of tax liability

You may need to pay taxes on forgiven student loans. Because of this, it’s worth pursuing the plan that leaves you with a lower balance after 20 or 25 years to avoid a hefty tax bill.

Both PAYE and IBR could help pay your interest

One nice perk of IBR and PAYE is their interest benefit for subsidized student loans. If your plan’s monthly payment is so low it doesn’t cover the interest on your loan, the government will pay the difference.

This benefit lasts up to three years from the day you begin repaying under PAYE or IBR. If you leave the program, lose eligibility or forget to renew your plan by the deadline, any unpaid interest could get added to your loan as part of the principal — known as capitalized interest.

IBR is easier to qualify for than PAYE

While PAYE may further reduce your student loan bills and get you out of debt faster than IBR, it imposes stricter eligibility requirements.

To get on the PAYE plan, you can’t have had any unpaid Direct or FFEL student loans as of Oct. 1, 2007, and you must have had a Direct loan disbursed on or after Oct. 1, 2011. And as noted above, the Department of Education plans to end new PAYE enrollments by July 2024.

By comparison, IBR has no “new borrower” qualification requirement.

IBR doesn’t require you to consolidate most loans

For some student loan borrowers, IBR may be easier to apply for than PAYE. That’s because unless consolidated, the following loans do not qualify for PAYE:

• Subsidized FFEL loans (both subsidized and unsubsidized)
• FFEL PLUS loans made to graduate or professional students
• FFEL Consolidation Loans that weren’t used to repay PLUS Loans made to parents

However, the rest of the above loans do qualify for IBR without consolidation.

That said, both plans require consolidation of federal Perkins loans. Although the Perkins Loan program expired in September 2017, they are still eligible for PAYE or IBR if you consolidate them first.

How to pick the best income-driven repayment plan for you

Overall, the Pay As You Earn (PAYE) plan comes out as the winner against Income-Based Repayment:

• PAYE lowers your monthly payments to 10% of your discretionary income.
• PAYE offers loan forgiveness after 20 years, no matter when you borrowed your loans.

However, qualifying for PAYE can be a hurdle for some borrowers. Meanwhile, IBR has an easier overall process, such as not requiring loan consolidation before applying.

Once you decide between IBR vs. PAYE, you must submit an official income-driven repayment application and recertify your income yearly. As your income rises, your student loan payments do as well. The silver lining is that your payments will always be within the threshold set by the 10-year standard repayment plan.

Other ways to reduce the cost of student loans

While income-based repayment plans can significantly reduce the monthly cost of your student debt, they aren’t the only option for debt relief. Here are additional ways to manage your student loans.

Student loan forgiveness

Several student loan forgiveness programs are available for borrowers with federal student debt. Here are some examples.

• Public Service Loan Forgiveness (PSLF): You may be eligible to have your loans forgiven if you work full-time for a government or non-profit organization. Criteria can be confusing, so contact your student loan servicer to discuss eligibility and how to apply.
• Teacher loan forgiveness: If you commit to teaching full-time for five years in a qualifying low-income school, you could have up to $17,500 of your loans forgiven.
• Military loan forgiveness: Members of the armed forces can apply for some or all of their student loans to be forgiven through various military loan forgiveness and repayment assistance programs.

Student loan grants

Depending on your profession, you may qualify for grants to pay off your student loans. For example, the Health Resources and Services Administration (HRSA) will pay up to 85% of a nurse’s unpaid educational debt in return for two years of service in a critical shortage facility or eligible nursing school.

Additionally, there are some employers that help repay student debt as an employee perk. While switching jobs just for debt relief might seem like a hassle, it could be worth it if your balances are unmanageable.

Student loan refinancing

If you don’t meet the IDR plan requirements, you may be able to lower your monthly payments with a student loan refinance.

Student loan refinancing can be a clever strategy for borrowers with a steady income and a good credit score. When you refinance, a private lender pays off your debt and issues you a new loan, hopefully with a lower interest rate and more flexible terms.

While extending your repayment term could lower your monthly bill, you will likely pay more interest over the life of the loan.

Be careful when refinancing federal loans

Refinancing federal student loans is generally not advised since you’ll miss out on certain benefits offered by the Department of Education, like student loan forgiveness, income-driven repayment plans and deferment and forbearance.

The main exception would be if you have a secure income and great credit that will allow you to find a better interest rate than what you’re currently paying on your federal debt.

Be sure to weigh the pros and cons of student loan refinancing before proceeding.