What happens to my interest on an Income-Driven plan?

For the Pay As You Earn and Income Based Repayment plans, for the first three years, if a borrower demonstrates Partial Financial Hardship, the government will subsidize the accruing interest on any subsidized loans above what is covered by the payment.  Meaning that if your payment covers $40.00 in interest but your account accrues $80.00 on subsidized loans, the government will pay the other $40.00.

Despite the fact that a borrower can qualify every year for this Partial Financial Hardship, the government’s paying of the interest still only lasts three years and is limited to subsidized loans.  For Income Contingent Repayment plans, the government will not pay any of the accrued interest regardless of situation.

There is an additional benefit when applying for the Pay As You Earn.  Normally if a borrower is no longer eligible for a PFH reduce payment, the interest on the account will capitalize.  However for PAYE plans, this is subject to a 10% limitation of the balance when the borrower entered the plan.  So if you have a $10,000 loan, you cannot have more than $1,000 in accrued interest capitalize under PAYE.

Any interest that does not capitalize because of this cap will remain on the account as accrued interest but not added to the principal and will not capitalize again unless the borrower removes themselves from the program.  However if a borrower fails to submit their annual recertification on time or voluntarily leaves the program, all this accrued interest will capitalize because the 10% limitation no longer applies.