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Financial Aid 101

By Anna Leider
With college costs continuing to rise at a rate more than double that of inflation, anxiety over college financing affects families at nearly every income level. At least some of this anxiety can be eliminated with more informed college planning. Financial help is available-plenty of it-to those families who understand the aid process, especially how colleges determine eligibility, what resources are available, and how to apply. So pay attention-there may be a quiz!
With college costs continuing to rise at a rate more than double that of inflation, anxiety over college financing affects families at nearly every income level. At least some of this anxiety can be eliminated with more informed college planning. Financial help is available-plenty of it-to those families who understand the aid process, especially how colleges determine eligibility, what resources are available, and how to apply. So pay attention-there may be a quiz!
The big cost picture
In the changing world of college planning, there are still three certainties.
First, college costs will continue to increase at a rate faster than inflation. At a 5% to 6% rate, students at private colleges will pay over $42,500 per year (on average) by their senior year. Students at public universities will pay more than $20,800 per year (on average) by their senior year.
Second, grant and scholarship aid is not keeping pace. This means families will have to rely more heavily on loans, current income, and their own savings to pay college bills.
Third, uninformed education consumers will make costly mistakes in financing college expenses:

• They'll spend their life savings-- money they'll need for their own retirement.
• They'll borrow money at unneces sarily high interest rates.
• They'll time their investments incorrectly, paying penalties and losing earning potential.
• They'll spend too much time looking for "special scholarships."
• They'll ask their children to attend colleges that are not right for them, thinking that they'll save money.
• They'll apply for aid after the money runs out; or worse, they'll neglect to file for financial aid at all, assuming they won't qualify.

Follow the traditional route.
Make sure you do both of the following:
First, don't panic: most students go to public, in-state colleges where the average cost is just over $17,500 per year. Even if you qualify for no financial aid, this amount can be financed fairly painlessly using low-interest student loans, extended payment plans, and contributions from student and parent earnings and assets.
Second, apply for financial aid, even if you think you won't qualify. Why? Because most families, even upper-middle income families, are eligible for federal assistance, especially for low-interest loan programs. Sometimes it takes a denial of federal aid to receive non-need-based college aid.
Financial aid nuts and bolts
Let's start with some definitions:

Grants and scholarships are gifts. They don't need to be repaid, which makes them the most desirable forms of financial aid.

Loans must be repaid. They count as aid because they are interest-free while the student is in school.

Work-study is just that-money students work for (in a job provided by the college) while they study. The money does not need to be repaid.

Need analysis is the official income/ asset evaluation that determines how much a family must contribute to the cost of college.

Expected Family Contribution (EFC) is the result of need analysis.

Dependent students are those who depend on their parents for support.

Independent students do not depend on their parents for support. Only their own income and assets, and those of a spouse, are evaluated to determine EFC. (Generally, single undergraduates must be at least 24 years old by December 31 of the award year to qualify. Orphans, veterans, wards of the court, students with legal dependents, married students, and graduate students also qualify.)

The definition of "financial need"
"Financial need" is the key to establishing eligibility for financial aid. Essentially, it's the difference between the cost of a particular college and the family's EFC. If the cost of a college exceeds EFC, the family has "need" and qualifies for need-based aid. For example, a family whose EFC is $11,000 considers two colleges: "Privy Ivy," which costs $30,000, and "State U.," which costs $11,000. At Privy Ivy, the family qualifies for $19,000 in aid; at State U., it qualifies for no aid at all. In other words, the true cost of college is not the price printed in the glossy brochure; it's the amount the family pays out of its own pocket. In this simplified example, the out-of-pocket cost of attending both schools is the same,$11,000.
Private scholarships
How do private scholarships fit into this picture? You may believe that scholarships will reduce your family contribution. For example, your family contribution is $11,000 and you win a $3,000 scholarship. You now say your contribution is only $8,000, right? Wrong! The college takes the $3,000 and incorporates it into your aid package. So at Privy Ivy, which you remember costs $30,000, your family contribution would remain $11,000 but your need would drop from $19,000 to $16,000. In this case, you would be wise to ask the aid administrator to use the scholarship to replace a loan element of your aid package. This way, even if the award doesn't reduce your out-of-pocket costs, it at least reduces the amount you repay after graduation.
At State U. there's some good news. Since it only costs $11,000 and you have no need, the scholarship can be used to reduce your family contribution from $11,000 to $8,000.
In short, private scholarships generally reduce the amount you pay out of your own pocket for college only if they are for an amount that exceeds your financial need. Of course, you should gratefully accept any scholarship money you're offered-since it can reduce the loan you'll eventually have to repay-but make scholarship searches a lower priority. Private scholarships comprise a small percentage of all available financial aid.
Determining "Expected Family Contribution" (EFC)
Understanding how to figure "Expected Family Contribution" is the key to formulating your entire financial aid strategy. For a dependent student, it's the sum of four separate calculations: 1) The contribution from parents' income, 2) the contribution from parents' assets, 3) the contribution from the student's income, and 4) the contribution from the student's assets. Because most student assistance comes from Uncle Sam, the exact formula for calculating eligibility is prescribed by Congress and is called the "Federal Methodology."
Let's look at the factors that go into these calculations one at a time.

• Parental income includes taxable and nontaxable income from the year preceding the award year (2006 for the 2007-2008 award year). From that, families receive a protection allowance for taxes and basic living expenses. For a family of four, that allowance is approximately $23,070. The bigger the family, the bigger the allowance. You may also subtract federal income taxes, social security taxes, and a variable allowance for state and local taxes. Finally, you receive an employment expense allowance of up to $3,200 if both parents work or if yours is a single-parent household. What remains is called available income, which gets multiplied by a percentage between 22% and 47%. The higher the available income, the higher the percentage (47% kicks in when available income exceeds $27,100).
• Parental assets include the value of stocks, bonds, trusts, savings, and business assets as of the date you sign the form. From that, you subtract a protection allowance-a nest egg for the golden years. For a student whose eldest parent is 47, that allowance is $45,300. The older the parent, the bigger the allowance. What remains is multiplied by approximately 5.6%. (Families with adjusted gross incomes below $50,000 who are eligible to file a 1040A or a 1040EZ don't have to include the value of their assets when calculating family contribution.)
• Student income. Students add up all their income and subtract federal income taxes, social security taxes, a variable allowance (of up to 6%) for state/local taxes, and an income protection allowance of $3,000. Students must contribute 50% of everything over that amount.
• Student assets. Students add up all their assets-they have no asset protection allowance-and must contribute a full 20% of their value.
• For independent students, only their own income and assets and that of any relevant spouse are evaluated to determine expected contribution.

Two special situations
There are two special situations:

• Two family members in college at the same time. In this case, the parental contribution to college costs may be divided by the number of family members (excluding parents) who are in college at least half-time.
• The parents are divorced or separated. In this case, students use the income and assets of the parent with whom they lived for the greater part of the 12 months preceding the date of the financial aid application. If the parent has remarried, the stepparent's income and assets must also be included for need analysis.

Applying for financial aid
Many students will have to go through two separate financial aid application processes: one for determining eligibility for federal student aid and another for determining eligibility for colleges' own resources.

• Applying for federal aid As soon as you know how much you (your family) earned in the preceding calendar year and as soon after January 1st as possible, you should fill out a federal need analysis form called the Free Application for Federal Student Aid (or FAFSA). You may complete the form online or send a paper version. In return you'll receive a Student Aid Report (or SAR), which is also sent to each college you designate.
  
• Applying for college aid Some schools, especially more expensive ones, will ask you for additional financial information before determining your eligibility for aid from their own resources. They may have their own form and/or use The College Board's Financial Aid PROFILE, which is available online only. The PROFILE is very much like the FAFSA, but you may be asked nearly 200 additional questions. You pay a fee for all this fun: $5 to register online plus $18 per school.
  

The "financial aid package"
Once they receive the results of need analysis, financial aid administrators (FAAs) create aid packages (a combination of grants, loans, and work study) to meet the need. Eligibility for federal student aid (and most state aid) is determined entirely from results of the FAFSA. Eligibility for college awards may be influenced by results from PROFILE (or the school's own aid application). If the family has no need and the college really wants the student, it may offer the student a non-need-based award-or recommend the family use one of Uncle Sam's non-need-based loan programs to help manage its cash flow.

• Pell Grants The bottom layer of the financial aid package consists of Pell Grants. Pell Grants are Uncle Sam's largest gift program. Students are eligible for a Pell if their EFC is about $3,850 or less. The smaller your family contribution, the larger the grant, within a range of about $400 to $4,050. Families can estimate the size of an award by subtracting their EFC from the maximum award size. For example, if the maximum award for 2007-2008 is $4,050 and your family's expected contribution is $1,000, your Pell Grant will be about $3,050. A $3,850 EFC, by the way, corresponds roughly to a family of four with an income between $45,000 and $52,000.
• Private scholarships As indicated earlier, private scholarships don't necessarily reduce a family's out-of-pocket costs! (They can, however, be used to replace a loan element of the aid package.)
• State grants The third layer of the package consists of any state grants the student might receive. States award over $9 billion in student aid every year. Most states require students to attend an in-state college to qualify for a state award. In most instances, the FAFSA will link students up with their home state's programs.
• Campus-based federal aid If, after all the packaging so far, a student still has need, the financial aid administrator will go to the fourth layer of the package-money that Uncle Sam gives to colleges for distribution. There are three of these campus-based federal programs:
• Supplemental Educational Opportunity Grants, which range from $100 to $4,000 per year. Priority for SEOGs goes to Pell Grant recipients; Uncle Sam gives schools over $700 million to award through this smaller grant program.
• Work-study, which provides students with part-time jobs on or off campus. Awards are made in dollar amounts. Students may work until they have earned this sum.
• Perkins Loans, which are low-interest, 5% loans that allow students to borrow up to $4,000 per year to a maximum of $20,000 for undergraduate studies. Uncle Sam pays interest on the loan while the student is in school and for a nine-month grace period following graduation.
• Subsidized Stafford Loans If you still need money, the financial aid administrator will certify you for a subsidized Stafford Loan. This is the federal government's largest student aid program. Currently, there are two parallel plans, the Regular Stafford, in which private lenders make the loan, and the Direct Stafford, in which Uncle Sam makes the loan. In the case of dependent students, freshmen may borrow $3,500 per year; sophomores may borrow $4,500. Juniors and seniors may borrow up to $5,500. The maximum amount an undergraduate may borrow is $23,000. Uncle Sam pays the interest while the student is in school at least half-time and for a six-month grace period thereafter. The rate equals 6.8% (previously it was adjusted annually and tied to the 91-day T-bill).
• College aid If federal and state programs are not enough to meet a student's financial need, the aid administrator can tap into the college's own pool of money; merit awards for academic, band, athletic, or other talent, for example. However, the college is free to reevaluate the family's financial situation and adjust the EFC up or down.
• Non-need-based aid If need remains, consider two federal loan programs: the Unsubsidized Stafford or the Parent Loan to Undergraduate Students (PLUS). All families are eligible for these loans, regardless of their income/assets.
• Unsubsidized Stafford Loans. Subsidized and unsubsidized Staffords are essentially the same except in the latter Uncle Sam does not pay the interest while the student is in school or during deferments.
  
  Independent undergraduate students may borrow additional amounts under the unsubsidized Stafford-$4,000 per year during their first two years and $5,000 thereafter, to a maximum of an extra $23,000.
  
  All students may defer repayment until after they finish school; however, interest begins accruing shortly after
  the loan is disbursed. Students must file the FAFSA to become eligible and refile each year to remain so.
• PLUS Loans. Credit-worthy parents may borrow up to the total cost of education, less any financial aid they've received. Repayment begins after the disbursement for the academic year. The interest rate equals 7.9% or 8.5%, depending on the lender.

Financial aid summary
Here are a few of the most important points in applying for financial aid.
First, apply for financial aid, no matter what. Second, use the right forms, and always file the FAFSA. High-tuition colleges will probably require the PROFILE and/or the college's own aid application. Third, apply as early as possible. Colleges tend to run out of campus-based aid rather quickly, both Uncle Sam's and their own. The early bird gets the financial aid worm. Fourth, be accurate when filling out the forms. Errors cause delays and can result in an inaccurate assessment of your situation. By the time you correct the information, the money may have run out. File online if possible. Fifth, be ready to verify the data on your aid application. Sixth, make copies of your aid application and your signed tax return. Put them in a safe place. Seventh, if the student is male, he must register for the draft.
The Higher Education Act, which establishes the main federal student aid programs, expires every five years. The next reauthorization is underway so you should expect some program changes, like new interest rates and increased repayment options, beginning in 2007 or 2008.
Getting the most for your college money In educating yourself about financial aid, you should have four goals:

• Maximize your chances for receiving financial aid by making wise college choices.
• Maximize your eligibility by preparing carefully for need analysis.
• Ease the cash flow crunch when the tuition bill arrives.
• Maximize your chances for a hefty tax refund by learning how the tuition tax credits work.

Wise college selection
You can improve your chances for a favorable aid package:

• Apply to schools where you're in the top 25% of the class profile. The best packages (those rich in grants) go to the most desirable applicants.
• Try for an academic scholarship. Over 1,200 colleges offer awards to bright students-some cover all college costs. Students with test scores that are 100 points short of qualifying them for an academic award should take a good SAT preparation course. It may bring them within the magic range. It's certainly worth investing $800 in a prep course when the payoff can be 10 times as great.
• Look for athletic scholarships.
• Stay in-state. Students who leave their home state often lose eligibility for state aid.
• Consider cooperative education. Over 500 schools sponsor co-op programs. Students alternate study with work in their area of interest, and participants can earn up to $15,000 per year. The catch? They may need five years to complete their degree.
• Mix it up. Spend the first two years at a community college. Study hard, then transfer to a four-year college.
• Accelerate. Do four years of college work in three, or earn college credits through AP or life experience.
• Ask questions. Is there a low-cost loan program? Middle income assistance? Are there installment plans? Prepayment bonuses? Retention awards or discounts for student leaders or alumni children?

Prepare for need analysis.
By knowing how Uncle Sam determines family contribution, you can present your financial picture in a more favorable way--one that lowers your EFC and increases your eligibility. Examples:

• Reduce your reportable assets by making large purchases and paying cash. Don't spend frivolously, but if you truly need a new refrigerator, buy one!
• Cut your per-student contribution nearly in half by having more than one student enrolled at the same time.
• Increase college-related costs. Make sure all your costs are reflected in the student expense budget. Special medical, child care, and transportation expenses can increase the "cost of attendance" figure, meaning more financial aid.
• Save for retirement. Money parents accumulate in retirement plans is generally tax-deferred and excluded from need-analysis calculations.
• Ask for a review of your aid package. However, before you do so, make certain all your requests are reasonable and that you have documentation to verify your claims.

Ease the cash flow.

• How? Here are some tips to help you through the college years.
• Investigate commercial payment plans. Such plans allow you to pay your tuition bill in installments.
• Check the military offerings. The National Guard, in particular, has been inventive and generous with student aid-just be sure you understand active duty requirements.
• Borrow against the house. Take out a home equity loan or line of credit; they're usually tax deductible.
• Take advantage of "teacher mania" and community service opportunities. Some colleges, most states, and Uncle Sam all have "forgivable loan" programs for prospective teachers and for community service.
• Sacrifice. This doesn't necessarily mean large sacrifices, but some of you may have to substitute fillet of fish at the local fast food chain for your favorite poached salmon at Chez Louis.

Getting tax refunds
Tuition payers are big winners come tax time, if they can make sense of the rules.

• The Hope Scholarship Credit allows families to claim up to $1,650 per student for tuition expense in each of the first two years of college. The credit equals 100% of the first $1,100 of tuition and 50% of the next $1,100.
• The Lifetime Learning Credit allows families to claim a credit equal to 20% of up to $10,000 in total tuition expenses. Part-time students are eligible, as are working adults who take classes to improve their job skills. But beware: these credits will be phased out for single filers with incomes between $45,000 and $55,000 and for joint filers with incomes between $90,000 and $110,000.
• Coverdell Education Savings Accounts (ESAs) allow you to sock away up to $2,000 per year for each student under the age of 18. Contributions are nondeductible, but the fund grows tax-deferred, and earnings are never taxed if the eventual distribution goes toward educational expenses, either for K-12 or for postsecondary education. Two things more:
• You may deduct interest paid on education loans. The maximum deduction is $2,500 per year, which will be phased out for single filers with incomes more than $50,000 and joint filers with incomes over $105,000.
• Single filers with incomes below $80,000 and joint filers with incomes below $160,000 may deduct up to $4,000 of education expenses per year, depending on income. (This deduction was allowed to expire, but will likely be extended retroactively.)

Conclusion Second only to buying a home, buying a college education is the most expensive purchase you are ever likely to make. Make sure it's an informed one. Read, research, plan, and prepare-some of the many resources available are listed on this page. In the changing education marketplace, you'll need to be a smart education consumer.
Anna Leider is president of Octameron Associates, publishers of books and pamphlets for college-bound students. This article has been adapted from Don't Miss Out: The Ambitious Student's Guide to Financial Aid by Robert and Anna Leider.