College Corner

Facts Regarding Financial Aid

Now is the time when college bound high school seniors and their families need to think about financing next year's college. The federal government has most of the aid, but much of their financial aid is need based aid. To be eligible for need based aid it is necessary to file the federal FAFSA (free application for federal student aid) form. They accept paper but prefer electronic filing after obtaining a PIN number. The web site is FederalStudentaid.ed.gov.

Once the form is filed and processed, the Department of Education sends a personalized Student Aid Report(SAR) which will include the amount of need based eligibility for aid. Some alternative non-federal sources use the Department of Education methods and procedures to determine financial need for their programs.

Need-Based Aid

Need based aid depends on family income and assets evaluated under the Department of Education's Effective Family Contribution(EFC) formula, or formula's since there are several. The EFC is an amount of money that can be expected as a family's contribution to the college Cost of Attendance. The Cost of Attendance(COA) is less complicated than the Effective Family Contribution, and amounts to the sum of expenditures compiled from an eligible list of college expenditures: tuition, books, supplies and so on. Financial need equals COA - EFC. Financial need is the maximum per year of eligibility for need based aid.

Filing for Effective Family Contribution requires lots of family financial information including income and assets in many cases. There is a simplified form which is simpler than the regular form, but not all that simple. The Obama Administration is making proposals that will simplify this form and its filing. Right now the simpler form can be used if income is below $50,000. In that case assets do not have to be reported. Both simplified and regular forms require reporting taxable and nontaxable income net of taxes and a dollar allowance graduated for the number of children in your family and the number attending college. For those with income over $50,000 add 12 percent of net worth to Effective Family Contribution.

Parents of dependent students and dependents must report income and assets on separate forms. Independent students use other forms but there are rules and definitions to determine dependence and independence. For families with annual income under $20,000 or anyone in a family receiving federal means tested aid such as food stamps and others automatically gets an EFC of zero. Simple comes at a price.

Types of Federal Aid

Federal financial aid comes in 3 types, which has been true for many years. They are (1) grants, (2) work study and (3) loans. Most of Federal financial aid is federal money administered through the financial aid office at participating schools, although student loans under the Federal Family Education Loan programs are bank loans. Schools do not have to participate but most do. Students receiving federal aid that has financial advantages like grants or subsidized loans must demonstrate financial need based on the procedures mentioned above.

Grants

Pell grants make up the heart of federal grants in aid, but there are Federal Supplemental Educational Opportunity Grants(FSEOG) and two new grant programs started in 2006: Academic Competitiveness Grants, and National SMART grants. The later two amount to a new branch of Pell Grants because they are only available to Pell grant recipients. Grants do not have to be paid back so they are always an advantage and a subsidy to students.

Pell grants go to eligible undergraduate students based on financial need up to a maximum which was $4,050 for the 2003 to 2007 academic years, but up to $4,731 for 2008. President Obama has proposed increasing the amount to $5,350 and then making them an automatic price adjusted program after that. Up through 2008 Pell grants have been a yearly appropriation funded by Congressional decision so that participating schools have funds for all those who qualify for grants, but only for that year.

Federal Supplemental Educational Opportunity Grants go to students with the highest financial need up to $4,000. Pell grant recipients are also considered for FSEOG funds. Participating schools receive a fixed allocation of funds for eligible students. When the funds run out the Federal Supplemental Educational Opportunity grants stop for the year.

Academic competitiveness grants go to undergraduate students and Pell grant recipients based on high academic performance. Funds are up to $750 for the first year and up to $1,300 for the second, but not for the third or fourth year. SMART grants up to $4,000 go to Pell grant recipients for the junior and senior year. Students must be pursuing a degree in physical, life, or computer sciences, engineering, mathematics or a critical foreign language to receive aid in the SMART program.

Federal Work Study

Federal work study students work on campus or do community service work while they are in school and no debts result from this aid. Federal work study is administered by participating colleges with jobs at the minimum wage and sometimes higher depending on the job. Funds to pay wages come from the federal government and jobs go to students based on their financial need. It is not entirely clear that a low wage job through a college is a subsidy to students unless low wage jobs are unavailable in areas near a college campus.

Loans

Federal loan programs are quite varied and some require financial need and some do not. All create legal obligations to repay which cannot be waived even in a bankruptcy court. Some loans are direct loans from the federal government and the school simply delivers the loan to a student.

Start with Perkins Loans which are direct loans and need based loans. Perkins loans go up to a maximum of $5,500 a year based on need with a $27,500 maximum at 5% interest for students who maintain at least half time status. The Perkins loans defer interest and payments until after graduation. Perkins loans are usually ten years and they are made from a federal budget allocation, but also loan payments go to the school to recycled into new loans.

Next the Department of Education has two other loan programs which are called the William D. Ford Direct Loan Program and the Federal Family Education Loan(FFEL) Program. Ford loans are direct loans because the lender is the U.S. Department of Education whereas FFEL lenders are private banks.

These loans have maximums up to $5,500 for freshman, $6,500 for sophomores, and $7,500 in later years. Ford loans are called Stafford loans, but both Direct Stafford loans and FFEL loans have subsidized and unsubsidized loans. Maybe you wondered about the subsidy. How much is the subsidy really?

The financial benefit of these loans varies but deferring monthly payments until 6 months after graduation can be worth several thousand dollars of subsidy depending on the interest rate. For a student who borrows $4,000 a year in interest deferred federal student loans, they will have $16,000 of debt 6 months after graduation. The monthly payment on a 10 year self amortizing loan would be $169.70 at 5 percent interest.

If 5 percent interest accumulation started immediately, student debt would be $18,549.57, which presumes yearly compounding and 4.5 years of interest accumulation. In that way, the federal interest subsidy is $2,549.57 on $16,000 dollars of loan principal. Monthly payments on the unsubsidized loans would be $196.75 instead of $169.70 on the Perkins loan. With a little subtraction you can count your subsidy every month for 10 years.

FFEL and Stafford loans of up to 25 years include the need based requirement. Subsidized Stafford loans carry an interest rate of 6.0 percent for 2008-9, but they have a 2.5% fee deducted from each loan disbursement. Apart from deferring payments a subsidy also results if the interest rate is lower than what is available outside the federal loan program: a loan in the market place. Federal Student loan interest rates are changed each year at the end of June. The interest rate for Stafford loans was published as 4.06 percent from July 1, 2002 until June 30, 2003. It was 6.8 percent in July 1, 2006 until June 30, 2007. Comparing the 6.0 percent rate above with 4.06 percent tells us that Congress has significantly reduced the interest rate subsidy lately, but the Obama administration is working to change that.

Plus loans are another federal student loan. Loans go to parents of dependent students and they are not need based loans. Plus loans have a limit of Cost of Attendance(COA) minus any other aid. Current interest rates on Plus loans are 8.5% for FFEL loans made through a private lender and 7.9% made as a direct loan through the Dept. of Education. There is a 4 percent loan origination fee. There is no grace period and payments must begin within 60 days. The interest rate for Plus loans was published as 4.86 percent from July 1, 2002 until June 30, 2003 so that Congress has significantly reduced the advantage of using Plus loans.

Loans have to be paid back and calling them financial aid implies they have advantages or favorable terms to students and their parents that are not available elsewhere. The subsidy will be bigger if the loan interest rate is lower compared to other market rates available. Of course, it is smaller the closer Congress sets loan rates to market rates.

With high Stafford and FFEL loan rates it is worth comparing home equity loan rates for families with home equity. Remember home equity loans have federal tax subsidies of their own. There are also Hope tax credits and Lifetime Learning tax credits.

In addition new interest rates are published. For the year ending June 30, 2009 subsidized student loans will have a 5.6 percent interest rate; after June 30, 2010 4.5 percent; after June 30, 2011 3.4 percent. Federal student aid will have more student aid in the future.

The Obama administration is proposing changes and expansion of the Federal Student Loan Program. They are proposing elimination of the FFEL program, which were loans by private lenders guaranteed by the Federal government. The private lenders got the interest payments, but the Federal government took the risk of default. Under the new proposals made the Federal Government would earn the interest as well as take the risk of default on all student loans. The additional interest earned will be recycled to fund student loan programs in later years.

There are also proposed tax credit and tax savings through Hope tax credits and Lifetime Learning tax credits. These are explained elsewhere in the College Corner by clicking Tax Financing Help.