The "Pay As You Earn" program is a pain in the neck of financial advisors across the United States. Pay As You Earn (PAYE) is probably the federal student loan repayment plan that I get the most questions about.
Just yesterday, I fielded the same tricky question about eligibility for PAYE from two different professional advisors in two different parts of the country, calling about two different student loan borrower clients.
The question professional financial advisors ask about Pay As You Earn most frequently is,
"Can consolidating make my client eligible for Pay As You Earn?"
The answer, of course, is "It depends." Under the right circumstances, a borrower who is not presently eligible to choose Pay As You Earn can become eligible by consolidating (and remember when I use the word "consolidating" I mean one thing only: repaying one or more federal student loans with a new federal Direct Consolidation Loan).
The PAYE program is weird in many ways. To get to the bottom of this thorny issue, let's start from the top.
Here are things worth knowing about Pay As You Earn (PAYE):
- PAYE has a Two-Pronged Wacky Borrowing Date Eligibility Requirement
- PAYE's Two-Pronged Wacky Borrowing Date Eligibility Requirement is a borrower specific requirement
- PAYE is a version of Income-Contingent Repayment
- PAYE is one of three available Income-Contingent Repayment plans (and BTW current law would permit the Department of Education to create additional ICR plans)
- PAYE came online after the original Income-Based Repayment (IBR) plan became available to borrowers in the summer of 2009
- PAYE came online after Congress passed amendments to the original Income-Based Repayment known as "New" Income-Based Repayment or "Income-Based Repayment for New Borrowers" that called for reducing payments to 10% of discretionary income from 15% of discretionary income and reducing the length of time before long-term forgiveness from 25 years to 20 years
- "New" Income-Based Repayment was scheduled for implementation, but not until the summer of 2014
- PAYE essentially fast-tracked implementation of the revisions to Income-Based Repayment
- PAYE's caps interest accrual at 10% of the original principal balance, but neither of the income-based repayment plans does the same
- PAYE has Loan Type requirements
- PAYE has Loan Status requirements
- PAYE has borrower-specific eligibility requirements
Pay As You Earn History
My memory is that Pay As You Earn was first announced by President Barack Obama at the University of Iowa when he was speaking to a crowd of undergraduate borrowers. The job market for recent grads wasn't the greatest, and people were struggling with student loans. Although the original Income-Based Repayment had been available since 2009, uptake was slow and more was needed. It was an election year.
The President announced that he would reduce required student loan payments and shorten the length of time a borrower must repay before canceling the remaining balance. The crowd went wild! Meanwhile, back in Washington DC, Congress failed to appropriate additional funding.
But wait! The Higher Education Act of 1965 had already conferred authority upon the Secretary of the Department of Education to promulgate rules for administering an Income-Contingent Repayment plan. The authority granted to the Secretary allowed the administration to create and implement a new Income-Contingent Repayment designed to look like the new Income-Based Repayment plan and going by the name Pay As You Earn. PAYE was created by an executive rulemaking process which is explicitly permitted by Congress via the Higher Education Act of 1965.
Before advising, know the rules
Don't hesitate to look up student loan rules in primary sources such as statutes and regulations. When you get to the complicated stuff, the consumer-facing materials created by the Department of Education and others may not provide sufficient detail. I often access the Code of Federal Regulations by using the wonderful and free online Legal Information Institute maintained by Cornell Law school.
Although only Direct Loans are eligible for enrollment in the Pay As You Earn repayment plan, a student loan borrower with FFEL program loans may include the balance on those FFEL loans when calculating the total balance used to determine whether or not a Partial Financial Hardship exists. Here's the relevant regulatory language:
Eligible loan, for purposes of determining whether a borrower has a partial financial hardship … means any outstanding loan made to a borrower under the Direct Loan Program or the FFEL Program except for a defaulted loan, a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower, or a Direct Consolidation Loan or Federal Consolidation Loan that repaid a Direct PLUS Loan or Federal PLUS Loan made to a parent borrower
Pay As You Earn Limits Capitalization
But Income-Based Repayment Does Not
Among the reasons I emphasize the importance of Pay As You Earn to student loan advisors is that Pay As You Earn offers access to the lowest required payments under the available Income-Driven Repayment plans as well as the shortest period of time until long-term forgiveness. However, that is also true of New Income-Based Repayment and, in the case of un-married borrowers with only undergraduate borrowing, REPAYE.
So what makes Pay As You Earn better than new Income-Based Repayment for a borrower?
Pay As You Earn caps the amount of interest that can be added to the principal balance of the loan when a borrower no longer has a partial financial hardship. Here is the language from the regulations:
Except as provided in paragraph (a)(2)(iii) of this section, accrued interest is capitalized -
(1) When a borrower is determined to no longer have a Partial Financial Hardship; or
(2) At the time a borrower chooses to leave the Pay As You Earn repayment plan.
(B)(1) The amount of accrued interest capitalized under paragraph (a)(2)(iv)(A)(1) of this section is limited to 10 percent of the original principal balance at the time the borrower entered repayment under the Pay As You Earn repayment plan.
(2) After the amount of accrued interest reaches the limit described in paragraph (a)(2)(iv)(B)(1) of this section, interest continues to accrue but is not capitalized while the borrower remains on the Pay As You Earn repayment plan.
Pay As You Earn's Two-Pronged Wacky Borrowing Date Eligibility Requirement
Here is that two-pronged wacky borrowing date eligibility requirement:
Eligible new borrower means an individual who -
(A) Has no outstanding balance on a Direct Loan Program loan or a FFEL Program loan as of October 1, 2007, or who has no outstanding balance on such a loan on the date he or she receives a new loan after October 1, 2007; and
(B)(1) Receives a disbursement of a Direct Subsidized Loan, Direct Unsubsidized Loan, or student Direct PLUS Loan on or after October 1, 2011; or
(2) Receives a Direct Consolidation Loan based on an application received on or after October 1, 2011, except that a borrower is not considered an eligible new borrower if the Direct Consolidation Loan repays a loan that would otherwise make the borrower ineligible under paragraph (a)(1)(iii)(A) of this section;
Super nerds may wish to read the full regulations regarding Income-Contingent Repayment plans here: https://www.law.cornell.edu/cfr/text/34/685.209
And so the answer is that a consolidation loan cannot cure ineligibility under the first prong of the eligible new borrower analysis.
In other words, if your client owed money on a federal student loan on October 1, 2007, and he or she did not fully repay that balance before borrowing his or her next federal student loan, consolidating will do anything to change that. However, if a client meets the first prong because he did not have an outstanding balance on a federal student loan on October 1, 2007, then we may move to the second prong. The second prong requires a borrower to have received a disbursement of a federal loan on or after October 1, 2011. A Direct Consolidation Loan can count as the loan dispersed after October 1, 2011, but only if it did not repay a loan that would otherwise make the borrower ineligible.
Phew! Got it ?
Learn more about Pay As You Earn and all of this crazy student loan stuff from me, Heather Jarvis, and my great and powerful colleague Jantz Hoffman at the Certified Student Loan Advisor Board of Standards.