Financial Aid 101

There are three strong reasons why you should complete the federal financial aid form, called the FAFSA (Free Application for Federal Student Aid):

1. To qualify for need-based financial aid
   Need-based financial aid consists of grants, student loans, and federal work-study jobs.
   
   • Grants are "free money" that you don’t have to pay back, such as scholarships and awards.
   • Student loans (that have to be paid back eventually) carry with them the advantage of low-interest rates that don’t start accruing interest until after the student has graduated.
   • Federal work-study, which are on-campus jobs often involving community service or work related to the student’s field of study.
2. To automatically establish a line of credit with the federal government that will allow the family to borrow as much low-interest, unsecured money as it needs to help with all college costs not covered by financial aid. If you don’t get enough financial aid from the college, you can turn to this reliable source of money.
   Low interest loans from the government provide some significant benefits:
   
   • You can use them to enable you to re-direct out-of-pocket "college money" to pay off higher-interest debt you might have.
   • If you have investments growing at 8% (for example) and can borrow relatively low-interest loans you can use these long-term government loans instead of cashing out your long-term investments to pay for college (and getting hit with capital gains taxes). Using "cheap" government money often makes good financial sense.
3. To hedge against the unforeseen. Jobs get lost, marriages fail, earthquakes and hurricanes happen, and our bodies sometimes fall victims to debilitating illness. In the event that any of these unpleasant and often unexpected events occur, if a financial aid form is on file at the college, you can call the financial aid officer at the school and discuss this "special circumstance." The law allows the college to recalculate the family’s ability to pay based not upon past income but on the projected income and asset picture created by this new condition. College personnel are usually very willing to help families in distress to continue with college. But the key to getting their help is having a FAFSA on file at the college the student is attending.

Need-based aid is the aid you need to pay for college. Need-based constitutes by far the lion’s share of available financial aid for college. The pool is deep (about $125 billion) and accessible. To qualify for need-based aid, students and parents will have to complete a federal form called the FAFSA or Free Application for Federal Student Aid. Some colleges will also request a second form called the CSS PROFILE produced by the College Scholarship Service, an arm of the College Board.

When you complete the financial aid forms, you list financial and other information and submit the form to a processing center that will calculate the amount your family will be expected to pay for one year of college. That amount is called the Expected Family Contribution or EFC. Because of slightly different formulas, the FAFSA will usually produce a lower EFC than the PROFILE.

As described in the first bullet point above, we strongly advocate that everyone, regardless of wealth or income should complete a FAFSA.

Non need-based aid. In layman’s terms these are called scholarships. They are typically competitive and sometimes require an essay or other documentation.
1. They tend to be small, in the $500-2000 range.
2. They are typically non-renewable. That is, if you get one, you will be ineligible to apply again the following year.

They are often tied to a conditions such as a religious affiliation, a specific talent or intended career. These scholarships are hard to get. Relying upon non-need based aid to fund college is a little like going to Vegas every year in search of college funds. It is a poor planning strategy to deal with college costs. What’s even worse: scholarship money can count AGAINST the need based financial aid you are entitled to receive. On the positive side, there is a growing trend by colleges, in an effort to recruit strong students, to offer some large, renewable (given every year) grants that are primarily merit based. It sometimes pays to be an outstanding applicant to a less-selective college than just another terrific candidate to a very selective college.

Here is how the EFC fits into the financial aid picture:

First, the actual cost of college needs to be known. If you want to find out what college costs, ask the college, "What is your cost of attendance (COA) or student budget?" This is usually much larger than the tuition, which does not include room and board and a host of other charges. Colleges usually have four known student budgets:
1. student living on campus
2. student living off campus
3. student living with relatives
4. student living at home

As a rule, the above categories are listed in descending COAs.

For the sake of illustration, let’s list three generic Costs of Attendance:

Let’s now assume a student has completed a FAFSA and his Expected Family Contribution was $10,000. Let’s also assume the student was accepted to a state university, a private college and an elite college. This is what the next step in the financial aid process would look like:

Note: the EFC remains the same regardless of what the college costs!

When it comes to calculating your EFC, there are dozens of variables at work. The four primary factors are:

1. The parent’s adjusted gross income. That’s the number at the bottom of the 1040 BEFORE you get creative with deductions. The EFC formula will ask for nothing if your reported income is very low and up to 25% or more if the reported income is over $100,000. As you report more income, your EFC will increase, and you will pay a higher percentage of your income to college.
2. The parents’ non-retirement assets. The EFC formula will total all of the parents’ reported assets, including bank accounts, stocks, bonds, and real estate equity (usually not the house you live in). You’ll be asked to contribute about 5.6% of that total for college.
3. The student’s total income from all sources. Typically, student income will not affect the EFC until it reaches $3,000. After that threshold is met and certain other allowances are considered, the EFC formula will expect that about 50% of every dollar of income will be added to the family’s EFC. For independent students the figure is even higher.
4. The student’s assets. Here, the EFC formula runs amok and goes after reported student assets at a rate of up to 25%. Again, it is even worse for independent students.

A financial aid administrator can turn to three sources for aid:

1. The federal government has about $125+ billion in its college financial aid coffers. As a financial aid administrator, I would surely look there first.
2. States are a good source of funds with each state having its own college support plans. Some states make those resources available only to residents of that state and only to students who attend colleges in that state. The amount available varies by state
3. The colleges themselves provide funds. There are several colleges with larger endowments than the gross national products of some third world countries.

Financial Aid comes in three forms and it is important that you understand each.

1. Loans are usually federal loans in the form of Stafford Loans (taken out through commercial lenders) or Ford Direct Loans (taken out through the government). Even though they have different names, they behave the same to the user. The need-based loans described here are what are called "subsidized loans." That means that while the student is still enrolled in college and/or graduate school, the government will pay the interest on the loan and the student may defer repayment until 60 days after leaving college and, in some cases, up to two years.

   The current maximum amount a student can use every year is:
   $3,500 in year one
   $4,500 year two
   $5,500 year three
   $5,500 year four
   $5,500 year five
   

   Independent students and graduate students can borrow much more. The current interest rate for 2007-08 is 6.8%. If the loan is subsidized, which need-based loans are, the student will not have to begin to pay back the loan until six months after he/she leaves college. There are many ways to tailor a payback plan to match the financial situation of the student following college.

   In addition to the Stafford or Ford loans, there is another loan called the Perkins Loan that is often used for needy students. The maximum Perkins loan is controlled by the government but is typically in the $4,000 range. Payback of a Perkins loan is usually done through the college. The Perkins Loan program is at risk under the current administration and may be terminated.

   Unsubsidized loans
   Any student –even if he/she cannot demonstrate financial need –can use these loans. The annual loan amounts are the same as subsidized but the difference is that they are unsubsidized. This means that repayment will begin about 60 days following full disbursement of the loan during that academic year or about March or April of the year. While repayment can be problematic for a student still in college, the student may elect to float the loan and let the interest accrue while in college and repay it afterward. One advantage of student loans is that the interest paid is tax-deductible.

   Some colleges have their own loan programs, which have better or even zero rates of interest.

2. Federal Work/Study is a need-based program that allows student to work on campus to help pay for college. Jobs are usually doled out on a first-come, first-served basis. Wages from work/study will not affect the student’s eligibility for financial aid the next academic year. Loans and work/study are considered to be "self-help" aid in that the student is require to shoulder some tangible responsibility in the form of either actual labor or in terms of paying back a loan with interest.
3. Grants and Scholarships. This is "free money" that you won’t have to repay. The most well-known federal grant program is the Pell Grant, which is intended primarily for low-income families. The maximum Pell Grant is just over $4,000 annually. Check with your state to see what grant programs are available and what qualifications you need to qualify. Most colleges have an endowment from which they make their own grants. While most are need-based, an increasing proportion is used as an incentive to "attract" highly qualified students in the same way colleges recruit football players. These grants can be substantial and are often extended for all four years. Often these grants are listed in the back of the college’s course catalog. If you need money, everything else being equal, it isn’t a bad idea to apply to wealthy colleges.

Congratulations, you are in! Along with an acceptance letter, a college will provide a newly-admitted student with an estimated financial aid award.The award offer should contain the following information:

The total cost of a year’s attendance at college (COA) or Student Budget.

Let’s say, for example, the COA is $42,000.

Next, the college should provide you with a statement of what the family will be expected to contribute. Often this is broken out into "Contribution from the student" and "Contribution for the Parent(s)." It might look like this:

They will then subtract the EFC from the cost of college to determine eligibility for aid or:

This is a great award. It balances self-help aid and free money and, most importantly, it meets the entire need. Do colleges always provide such exemplary financial aid awards? No. When you are confronted with an inadequate award, you don’t have to accept it. You can negotiate a better financial aid offer by using the strategies we’ve supplied in "Evaluating & Negotiating Financial Aid Offers" and "Negotiation Tips for Financial Aid."

Let’s say your student gets a scholarship for $2,000 from the Rotary Club. What happens to that money? Typically, the Rotary Club will send the check directly to the college. The college cashes the check and lowers their aid offer to the student on a dollar-for-dollar basis. So the Rotary Scholarship did not help the student at all. Rather, it helped the college or even the federal government who would no longer have to underwrite the needy student.

In many lunchtime speeches to Rotary Clubs and Kiwanis we have described their well-intentioned efforts as like "wetting your pants in winter. It gives you a warm feeling but it only lasts a while!"

There are some solid approaches to making outside scholarships more useful. TuitionCoach outlines all of them in "Negotiating Tips for Financial Aid".

What should you do if you receive one of these scholarships? Thank the donor and tell them to hold onto the scholarship until you get back to them. Then call the financial aid administrator at the college and tell them that you MIGHT receive a $2000 scholarship but before you accept it, you want to know what the college will do with it. The financial aid officer may ask you what you would like them to do with it. Give them two options. First, ask them to apply the $2000 to lower your family contribution. This is in violation of the federal rules so you will most likely get a "No." Then ask, will the college use the $2,000 to replace any self-help aid in the package?" Self-help aid refers to loans and work/study so lowering student loans by $2,000 does, in fact, help the family. If they are willing to do this, take it. It may have a small tax implication but it will be worth it.

If the college refuses to negotiate, you still have some options open. Call the donor of the scholarship and request that they keep the money in an interest-bearing account until the following spring. Ask them if they would be willing to send the check directly to the student loan lender, provided, the student shows up with his/her grades and a copy of the promissory note for a student loan and the address of the student loan lender.

In this way, the money helps the student by reducing the amount they must borrow. It also guarantees the student is rewarded after the fact rather than before. After all, if the club sent a check to the college in the fall of the freshman year, they have no guarantee that the student will stay at the college or will complete the year. In short, be smart when it comes to dealing with outside scholarships.

College funding is essentially a two-part problem. In part one you must understand the Expected Family Contribution and how to minimize it. In part two you must figure out how to deal with costs not covered by financial aid. In other words, now that you know what college costs, how will you pay for it?

TuitionCoach will walk you through the entire process, step by step. By the time you are done you will feel confident you have lowered the cost of college, and made intelligent choices about how to pay for it. You will be able join with your children in an unconditional celebration of their achievements thus far. Together you can look forward to a future that provides all the life opportunities their interests and talents demand.