Many people are intrigued when they read about the REPAYE interest subsidy. However, very few know the financial details surrounding it.
In this article, I detail what you need to know about the REPAYE interest subsidy and how to take advantage of it.
FitBUX Members’ that do this strategy correctly save between $20,000 and $30,000 (Note: Average owed is $144,000).
First Things First: The REPAYE Interest Subsidy Is Complex
There are a lot of moving parts to the REPAYE interest subsidy. The repayment strategy I’m going to be reviewing in this article can save you the most money. However, its also the most complex student loan repayment strategy.
Therefore, I do not recommend this strategy for most people. The reason is statistically, if you don’t understand how a financial strategy works, you aren’t going to do it in the long-run. Even worse, you may do it wrong.
Thus, this is my warning to you. If you don’t understand the information in this article, don’t do it.
Stick to something more simplified that you do understand and you’ll be better off in the long run.
REPAYE Is An Income Driven Repayment Plan: Know How They Work
There are now nine different repayment plans that the Federal Government offers and they are confusing. Therefore, at FitBUX, we break it down into two categories: Pay Off Strategies and Loan Forgiveness strategies.
This is where the REPAYE Interest Subsidy and the corresponding repayment plan gets complex. REPAYE is classified as a loan forgiveness plan.
However, the complex repayment plan is where you use REPAYE but actually pay off your loans.
Before I explain the REPAYE interest subsidy and how to take advantage of it, you have to understand how income-driven repayment plans work.
As I discuss in our income driven repayment guide, one of the key items to understand when it comes to student loans is the monthly interest charge.
The interest charge is the portion of your monthly required payment which is used to pay the interest on your loan. The rest of your payment is used to reduce how much you owe.
If you are on an Income Driven Repayment (IDR) plan and your required monthly payment is lower than the monthly interest charge, that “unpaid” interest is deferred and added to your loan balance. Translation, how much you owe increases each month.
When you are on an IDR plan other than REPAYE, 100% of that unpaid interest is deferred i.e. its all added to your loan balance.
How The REPAYE Interest Subsidy Works
REPAYE is different than other IDR plans such as PAYE because it incorporates an interest subsidy. Each month on the 1st, 2nd, or 3rd business day, the government will forgive half of the interest that you deferred from the previous month.
For example, let’s say you are charged $1,000 per month in interest. If your required monthly payment on REPAYE is $300 then you defer $700 in the current month ($1,000-$300). On the 1st, 2nd or 3rd business day of the following month, the government will subsidize $350 of the interest ($700/2=$350). Therefore, your balance only grows by $350.
Note: We include the REPAYE interest subsidy in our income driven repayment calculator. This is important because it gives you a better estimate of your tax liability when your loans are forgiven.
Another Important Note: Under President Biden’s REPAYE proposal that is pending, the REPAYE interest subsidy would change to 100%!
Who Shouldn’t Use The REPAYE Interest Subsidy
Before diving into the strategy of using REPAYE to pay off your student loans, we have to first discuss who benefits from the REPAYE interest subsidy and who doesn’t.
Many get enticed by the subsidy that is unique to REPAYE. However, when you do the math, REPAYE doesn’t make financial sense for most people when compared to other IDR plans.
Specifically, if you are pursuing student loan forgiveness and plan on working full-time for 25 years. REPAYE most likely is a major disadvantage from a cost perspective. This occurs because REPAYE last 25 years vs. 20 for the other IDR plans. (Note: REPAYE is 25 years for graduate students only).
In most cases, your income in years 20 – 25 will likely be higher than years 1 – 20. Therefore, the amount you pay as a monthly payment will increase faster AND you’ll have to make 60 additional monthly payments!
These extra 5 years of payments often times negate the savings you get from the interest subsidy. Thus, you’d be better off sticking with a 20-year plan and use PAYE or IBR For New Borrowers.
Also, if you get married then regardless of how you file, your taxes are based on dual incomes and combined Federal student loan debt. This can cost you a lot in the long run as well. This is also why undergrads will most likely not want to use REPAYE vs PAYE. (Note: This also may be changing if Biden’s REPAYE proposal goes into law).
The Best Pay Off Strategy Using The REPAYE Interest Subsidy To Your Advantage
We typically see this advanced pay off strategy work for approximately 1 – 4 years. After this time period you’ll want to switch to a standard plan or refinance your student loans.
Here are the steps to take to use this strategy:
- Set up your monthly payment on auto-pay. ONLY make this payment during the current month.
- On the 3rd or 4th business day of the next month, make a prepayment to the specific loan you want to pay off first. Remember, the REPAYE interest subsidy happens on the first day of each month. Thus, the reason for waiting to make your prepayment till the 3rd or 4th business day.
- Make your prepayment to the high interest rate loan or low balance loan.
Calculating The Effective Interest Rate
Earlier, I mentioned that you’d want to do this strategy for 1 – 4 years. One of the keys to determining when to stop is the effective interest rate.
Once your effective interest rate is about the same rate as you could get by refinancing your student loans, then you’d most likely benefit by refinancing.
Let’s look into how to go about calculating the effective interest rate while incorporating the REPAYE interest subsidy.
We’ll assume that your required monthly payment is $0 per month and your interest charge each month is $720 (I’m assuming I have $144k in loans at a 6% interest rate). Therefore, I am deferring $720 per month ($720 – $0).
On the first business day of the next month, the government is subsidizing half of my deferred amount. Thus, I’m only deferring $360 per month. I multiply the $360 by 12 which results in $4,320. That is a rough estimate of how much I’m charged over 12 months.
I then take $4,320 and divide it by the amount I owe which is $144,000. The result is 3%. That is my effective interest rate.
Understanding Why This Advanced Strategy Only Works For 1 – 4 Years
Calculating the effective interest rate is key to understanding why this strategy only works for 1 – 4 years. There are two factors that determine this.
Factor 1: Your income goes up.
Factor 2: The amount you owe goes down.
Let’s look at an example to see how this works:
Using the example in the preceding section, let’s assume one year has past.
My monthly payment is now $300 per month and I defer $273 in interest. Half of the deferred interest is subsidized the first of the month. Therefore, I owe $136.50 in interest.
I have to add the amount I actually paid plus the deferred interest ($300 + $136.50 = $436.50). The result of this number is how much I owe in interest so I multiply it by 12. The result is $5,238.
Let’s also assume that I was able to reduce how much I owe from $144,000 down to $113,400.
Therefore, I take $5,238 and divide it by $113,400 for an effective interest rate of 4.62%.
At that point, I’d want to either look into refinancing to see if the rate is below 4.62% or I’d want to switch into a standard repayment plan.
Who Else Can Take Advantage Of The REPAYE Interest Subsidy?
Those that want to pay off their student loans fast and want to do so in the most efficient way possible benefit most from the REPAYE interest subsidy.
We are going to deeper dive into how this works in the next section. However, before we do, I want to discuss other situations that you may find yourself in whereby you can take advantage of the REPAYE interest subsidy.
Taking Advantage Of The REPAYE Interest Subsidy When Having A Short-Term Decline In Income
If you plan on paying off your loan the “traditional” way, i.e. using a pay off strategy but have a short-term decline in income, then you can benefit from the REPAYE interest subsidy. Here is why.
Using REPAYE in the short-run would decrease your monthly payment.
The REPAYE interest subsidy would benefit you since you only plan on using REPAYE for a short period of time.
If you elect to go that route, you can change back to a traditional repayment strategy easily when your financial situation improves and you’re able to make the higher monthly payments. You can switch from REPAYE to a pay off strategy any time at no cost.
For example, we see many physicians or physical therapist doing their residency. During this time their income is low but after the residency is completed, their income will increase and they will want to pay off their loans.
These individuals can benefit from the interest subsidy because they would defer less interest. Therefore, how much they owe would grow more slowly and, ultimately, the amount they would have to repay when they go back to a traditional pay off strategy would be lower.
Not Expecting To Work Full-Time
You can also benefit from the REPAYE interest subsidy if you don’t expect to work full-time for 25 years. The reason being is you wouldn’t have to make the extra 60 payments in years 20 – 25 of the loan because you wouldn’t be working.
If You’re On Old IBR, Then Switch To REPAYE
Lastly, if you are on Old IBR, you’ll want to look into REPAYE for a couple of reasons:
- Old IBR is 25 years long and the monthly payment is 15% of your adjusted gross income. REPAYE is also 25 years long (for those that went to grad school) but the monthly payment is only 10% of gross income.
- REPAYE has the interest subsidy and Old IBR does not. Therefore, the tax you will pay when your loans are forgiven will be less if you switch to REPAYE.
However, if you are on Old IBR, the switch is not automatic. Two things to be aware of:
- If you switch, the deferred interest that you already accumulated will be capitalized. e. it will now begin to compound interest whereas currently it does not.
- On old IBR, if you are married then you can file taxes “Married Filing Separately” and the monthly payment is only based on your income. On REPAYE however, your filing status doesn’t matter. Your payment is always based on combined incomes. Therefore, switching may actually cost you a lot. (Note: If Biden’s REPAYE proposal becomes law, this will change).
Make Sure You Get The Interest Subsidy
The REPAYE interest subsidy is supposed to happen the first business day each month. However, to put it nicely, loan servicers suck. Therefore, they don’t always do it. Some don’t do it all. Other times, they randomly will do it every three months.
Bottom line, make sure you are getting the subsidy if you are using a strategy that involves the REPAYE interest subsidy. This is also one of the reasons why many people don’t use this strategy, i.e. they don’t want the headache of dealing with the Federal loan servicers.
Extra Items Too Know About REPAYE
Item 1: Your monthly payment is based as a percentage of combined incomes & combined Federal student loans if you are married.
Item 2: Certify your income each year. This is where you have to show the government how much you made the year before and it determines your monthly payment for the next year.
Item 3: You have to know when to stop. As previously mentioned, the effective interest rate is important as well as your required monthly payment.
Item 4: Subsidized loans are charged 0% interest for the first 3 years post-graduation. This is a major benefit to you and decreases the effective interest rate.
Extra Tips For Students & New Grads To Maximize Savings
REPAYE is based on your income. One of the ways you certify your income is by using your tax return. This in turn determines your monthly payment for the next twelve months.
Therefore, you’ll want to file a tax return while you are in school because your income will be lower than it will be once you graduate. Thus, your monthly payment will be low or $0 for the first 12 – 24 months post-graduation. The lower your monthly payment is the more you benefit from the REPAYE interest subsidy.
How did we find out about this trick? We’ve been on multiple phone calls with FitBUX Members and their loan servicer whereby the loan servicer actually advised them to do this! Thus, you can take advantage of this as well.
Conclusion On Using The REPAYE Interest Subsidy To Your Advantage
Most people will not benefit from the REPAYE interest subsidy and are better off using PAYE or IBR.
There are unique situations however where you may take advantage of it. Primarily, if you are paying off your loans aggressively you can save a ton of cash.
Also, if you are only going to be using REPAYE for the short-term or you are on old IBR then you’ll want to think about it.
If you need help discussing the REPAYE interest subsidy or just generally need help building out your financial plan, we are here for you.
Our financial planning technology is built specifically for young professionals and our FitBUX Coaches are expert student loan planners.
To get help, simply go to FitBUX.com, become a member, and schedule a call when you get to your dashboard.
How does the prepayment not disqualify the interest subsidy for the following month?
Good question. The interest subsidy is based on the amount of interest accrued during the previous month. If you make your prepayment the first or second business day there is little to no interest accrual. Therefore, more interest will have 28 – 30 days to accrue. If you waited so say day 28 to make the prepayment, then you would be getting less subsidy because the payment would be reducing interest.
My husbands dental loans are at an average of 6.3% with 430K loan balance. The interest on this per month is $2,257 a month. His gross income in 2021 (just started practicing) was $104,000 which would make his monthly required payment of $866 a month. So then $1,391 would be the left over interest and half of that is subsidized which means only $695 is added to his balance? But you can wait until the next month and dump a few thousand above the minimum due since we want to pay them off in 7 ish years.
We are married now so would our combined income be used next year to calculate the new monthly minimum?
Just trying to figure out if this could be beneficial for us over a few years until the effective rate is up to 6.3% and we could refinance at that point.
Your combined income would be used to calculate the payment. However, This might not happen. As of now you don’t have recertify until late in 2023 so they might use his tax return from when he was single, pending on when you got married. I.e. I’m assuming you recently got married because you said, we are now married. He may also get away with low payments for one more year if he submits a tax return from when he was single.
There is an article about this in white coat investor that basically says you can’t do this? Do you know if things have changed and now you can?
People have been doing it for years so not sure why there would be an article saying you can’t do it. What might be stated in the article is that you can no longer lie about your income and expect to get away with it.
Come 2021 I’ll be starting to try to maximize subsidy…so would love clarification before my attempt, so maximally interested in your thoughts.
https://www.whitecoatinvestor.com/repaye-interest-subsidy/
The key is to make the prepayment on the 2nd or 3rd business day after the interest subsidy was given.
Hi Nathan-
No there are no repercussions for paying it off early. You don’t have to pay back any of the interest that was subsidized.
This was my question, say we stay on this for 3 years and follow this plan then swap to standard repayment are there any tax implications for the subsidized interest? I’ve heard of the tax bomb so wasn’t sure if I’d need to save…. Also will SAVE work same way since it replaces this now?
Hi Matt-
There would be no tax on the interest subsidy. Yes, from our understanding SAVE will work the same way. However, we do not know the details on how they are going to forgiven the interest on SAVE yet.