PAYE vs. SAVE: Which is better?

Over the past 20 years, the amount of money students have borrowed for their college education has ranged from $66.8 billion to $152.8 billion. This was generated by the 30 percent of all adults who took on student loans to help pay for their college education.

Making payments on outstanding student loans has become increasingly difficult. If you’re having a hard time making your federal student loan payments, an income-driven repayment (IDR) plan like Pay As You Earn (PAYE) or Saving on a Valuable Education (SAVE) Plan can help.

PAYE and SAVE plans are repayment plans for federal student loans that cap your payment at 10 percent of your discretionary income. After 20 or 25 years of payments, your remaining balance is forgiven.

The choice of the PAYE versus SAVE program comes down to your level of financial hardship, preferred repayment period and payment cap.

PAYE is typically the better option for married borrowers, while SAVE is usually better for single borrowers.

PAYE vs. SAVE: Key differences

What is Pay As You Earn (PAYE)?

Pay As You Earn is an income-driven repayment plan that generally bases your monthly payment on 10 percent of your discretionary income. However, your payments cannot exceed what you would pay under the standard 10-year repayment plan. Additionally, if you’re married but file separate tax returns, your spouse’s income will not be included in the calculations.

According to student loan expert Mark Kantrowitz, PAYE yields the lowest monthly loan payments for most borrowers. After 20 years of payments, your student loan balance will typically be eligible for forgiveness.

Only Direct Loans made to students are eligible for PAYE, though certain FFEL and Perkins Loans are eligible if consolidated. To qualify, you must be a new borrower (having no outstanding loan balance before Oct. 1, 2007), and your loans must have been disbursed on or after Oct. 1, 2011.

With PAYE, your monthly payments might be too small to cover the interest your loan accrues monthly. This is known as negative amortization. However, with the PAYE program, surplus interest charges on subsidized loans are not capitalized, which means those interest charges are not added to your loan’s principal balance. Instead, the federal government covers those interest payments for the first three years of your loan. However, if you leave the plan, some interest may be capitalized and added to your principal balance.

What is Saving on a Valuable Education (SAVE) Plan?

Formerly known as the Revised Pay As You Earn plan, the Saving on a Valuable Education (SAVE) Plan is also an income-driven repayment plan that limits the size of your federal student loan payments. It increases the income exemption from 150% to 225% of the poverty line, allowing for far lower payments than other IDR plans. Monthly payments are based on your discretionary income, which is the difference between your adjusted gross income (AGI) and 225% of your family size, according to the U.S. Department of Health and Human Services Poverty Guideline.

Payments

One unique feature of the SAVE Plan is its approach to monthly interest. When you make your full monthly interest payment, the government will automatically cover any extra unpaid monthly interest, so you don’t get penalized for unpaid interest.

Borrowers formerly under the REPAYE Plan are automatically enrolled for the new SAVE Plan benefits. However, spousal income is only included if you file taxes together. If you are married but file taxes separately, the SAVE Plan does not include spousal income when calculating your payments.

Eligibility

SAVE plans cover a variety of loans, including the following.

Loans Eligible for a SAVE Plan

2024 upcoming benefits

Additional benefits are set to be added in July 2024, including the following:

• Loan payments for undergraduate borrowers will go from 10% to 5% of their discretionary income.
• Borrowers with undergraduate and graduate loans will pay a weighted average between 5% and 10% of their income based on the loan’s original principal balance.
• If your original principal balance was $12,000 or less, you could receive forgiveness of any remaining balance after ten years of payments, with a maximum repayment period before forgiveness increasing for one year per additional $1,000 borrowed.
• Loan consolidation will still count toward forgiveness.
• Credit will automatically apply toward forgiveness for certain periods of deferment and forbearance.
• Those who are 75 days or more late on their monthly payment will be automatically enrolled in an IDR plan with the lower monthly payments.

Which is better: PAYE or SAVE?

There are several factors to consider when deciding whether you should choose SAVE or PAYE:

• SAVE offers lower payments, calculating payments based on 225% of the federal poverty standard instead of 150% for PAYE plans.
• PAYE only subsidizes unpaid interest for the first three years of the loan, while SAVE lasts for the entire life of your loan.
• For both the SAVE and PAYE plans, borrowers who file taxes separately do not have to include their spouse’s income for their loan.
• While PAYE has a monthly cap on its payments, SAVE does not, so you could end up paying more than the Standard 10-year plan amount should your income rise and your debt become lower.
• With a SAVE plan, graduate debt is not forgiven until 25 years, compared to the 20 years associated with the PAYE plan.

How to determine if IDR is right for you

When choosing an IDR plan, there are a few things to keep in mind.

• Determine if you qualify: Before you can get a loan, you need to know if you qualify. Calculate your annual household income and family size, then match it against the federal poverty guidelines to see if you meet the requirements for an IDR plan.

• Calculate your payments: Now that you know you qualify, you can use the Federal Student Aid’s Loan Simulator. Be sure to include details like your income, family size, tax filing status and the state where you live.
• Consider timelines. Think about how long each plan will take to pay off. A PAYE loan typically takes 20 years for repayment, but you could be paying for as long as 25 years with a SAVE plan if you are a graduate student.

Can you switch from SAVE to PAYE?

You can change repayment plans for federal student loans and switch between any of the plans. Kantrowitz suggests contacting your loan servicer if you want to change repayment plans. With all of the additional benefits coming in July 2024, it may make sense for borrowers to change plans when the extras kick in.

However, keep in mind that you will need to disclose your income when you change plans. This could increase your monthly payment if you make more now than when you originally applied for the loan.

Crunch the numbers with a loan calculator or talk to your loan servicer about your plan to switch programs. It can explain how your monthly payment may change.

Things to keep in mind for IDR plans

There are a few things to keep in mind before you choose an IDR plan.

• Your credit score can be affected. An IDR application alone won’t require a hard credit check, but you could still see changes to your score as you make payments. For example, if you miss payments, you will likely see your credit score drop in response.

• You cannot have existing defaulted loans. If you have a loan in default, you will not be eligible for an IDR plan. In this case, a student loan consolidation may be a better bet.
• You could pay more in interest. IDR plans could end up costing you more in interest because they are spread out over a longer period of time than other types of personal loans.
• Forgiveness isn’t entirely free. Even if your debt is forgiven after 20 or 25 years, you may still have to pay state income tax. State tax may be assessed on any forgiven amount when there is a balance left at the end of the repayment period.

Alternatives to PAYE and SAVE

The Department of Education offers four income-driven repayment plans. Depending on your income, family size and loan type, a different plan may be a better option for you. The official Federal Student Aid website offers a loan simulator to calculate your estimated monthly payment for each repayment plan. Thankfully, you only need to submit one application to be considered for all IDR plans.

If you don’t think an income-driven repayment plan is your best option, you can also lower your student loan payments by refinancing your loans with a private lender to get a lower interest rate. That might help you save money and potentially help you pay off your debt sooner.

Bottom Line

The PAYE and SAVE payment programs for federal student loans offer borrowers ways to decrease their monthly payments. Eligibility status, income and marital status are treated differently for the two programs, so it’s important to consider these factors when deciding which program to choose.