PAYE vs ICR: Pursuing higher education in the United States is often a financial challenge due to the high cost of tuition and associated fees. For many students, taking out federal student loans is the only feasible way to fund their education. However, once they graduate, the challenge of repaying these loans begins, often leading to stress and financial strain.
The federal government offers several repayment plans to ease this burden, including the Pay As You Earn (PAYE) and Income-Contingent Repayment (ICR) plans. This article explores these two options to help borrowers determine which plan might be more beneficial for their circumstances.
What loan repayment plans are offered at the federal level?
Federal student loans come with various repayment plans to accommodate borrowers with different financial situations. While the Standard Repayment Plan sets fixed payments over 10 years, income-driven repayment (IDR) plans adjust monthly payments based on the borrower’s income and family size. PAYE and ICR are two of the four primary IDR plans available:
- Pay As You Earn (PAYE)
- Income-Contingent Repayment (ICR)
- Revised Pay As You Earn (REPAYE)
- Income-Based Repayment (IBR)
- This article will focus on comparing PAYE and ICR
What is Pay As You Earn (PAYE)?
The PAYE plan was introduced to make student loan repayment more manageable for borrowers with lower incomes. Under this plan:
Monthly Payments: Payments are capped at 10% of the borrower’s discretionary income.
Repayment Period: Any remaining balance is forgiven after 20 years of qualifying payments.
Eligibility: Borrowers must demonstrate partial financial hardship and must have taken out loans after October 1, 2007, with at least one disbursement after October 1, 2011.
Loan Types Covered: Direct Loans, including Direct Subsidized, Direct Unsubsidized, and Direct PLUS Loans for graduate students.
Benefits of PAYE: Lower monthly payments compared to standard plans. It offers a shorter forgiveness period of 20 years and provides an interest subsidy, where if monthly payments don’t cover accruing interest on subsidized loans, the government covers the difference for up to three years.
Drawbacks: PAYE has strict eligibility criteria, and forgiveness amounts may be considered taxable income.
What is the Contingent Repayment plan (ICR)?
The ICR plan offers more flexibility and fewer eligibility restrictions, making it available to a broader range of borrowers. Key features include:
Monthly Payments: Payments are either 20% of discretionary income or a fixed amount based on a 12-year repayment term, whichever is lower.
Repayment Period: Remaining balances are forgiven after 25 years of qualifying payments.
Eligibility: Available to all borrowers with eligible federal loans, without the requirement of demonstrating financial hardship.
Loan Types Covered: All Direct Loans, including Parent PLUS Loans (if consolidated).
Benefits of ICR: ICR has broad eligibility, including for Parent PLUS Loan borrowers via consolidation, and provides flexible payment calculation options.
Drawbacks: It has higher monthly payments compared to PAYE, a longer forgiveness period of 25 years, and interest can capitalize more frequently, increasing the total repayment amount.
PAYE vs ICR: Which Plan is More Beneficial for borrowers?
The choice between PAYE and ICR depends on individual circumstances, including income level, family size, loan balance, and long-term financial goals. Below is a comparison of key factors:
PAYE is More Beneficial if:
Borrowers with a low income who qualify for partial financial hardship might find PAYE more suitable. It is also advantageous for those wanting lower monthly payments and prioritizing shorter forgiveness periods.
ICR is More Beneficial if:
Borrowers who do not qualify for PAYE, have Parent PLUS Loans and are willing to consolidate them, or prefer flexible eligibility criteria might find ICR a better option.
Other factors to consider when choosing a student-loan repayment plan
Tax implications of forgiveness are significant since both PAYE and ICR forgiven amounts are considered taxable income under current tax law. Borrowers pursuing public service may qualify for Public Service Loan Forgiveness (PSLF), which forgives remaining balances after 10 years of qualifying payments under PAYE or ICR. PAYE benefits borrowers with a growing family or stable income, while ICR might be better for those with fluctuating income or higher loan balances. Although PAYE offers lower monthly payments, the total repayment amount could be higher if the borrower’s income increases significantly over time.
