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 expenses. 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 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. Families with annual income under $20,000 or anyone in a family receiving federal means tested aid such as food stamps automatically get an EFC of zero. Simple comes at a price.

Types of Federal Aid

Federal financial aid comes in 3 types. This has been true for many years. They are (1) grants (2) work study and (3) loans. Most Federal financial aid is federal money administered through the financial aid office at participating schools, although some student loans 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 also Federal Supplemental Educational Opportunity Grants (FSEOG) and two new grant programs started in 2006: Academic Competitiveness Grants, and National SMART grants. The latter 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 2006-7 academic year. Pell grants are funded so that participating schools have funds for all those who qualify for grants. 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. No debt results from this aid. Participating colleges administer federal work-study. Compensation is at the current 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. 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. Perkins Loans are need-based loans. Perkins Loans go up to a maximum of $4,000 a year with a $20,000 maximum at 5% interest for students who maintain at least half time status. The Perkins Loans defer interest and payments until after graduation. Perkins loan payment terms are usually ten years.

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. Ford loans are called Stafford Loans.

FFEL and Stafford Loans have subsidized and unsubsidized loans. Subsided loans of up to 25 years have the need-based requirement. Subsidized Stafford loans carry an interest rate of 6.8 percent for 2006-2007, but they have a 3% fee deducted from each loan disbursement. The subsidy comes primarily because interest is zero for borrowers until 6 months after leaving school. 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. The interest rate for Stafford Loans was published as 4.06 percent from July 1, 2002 until June 30, 2003, so that Congress has significantly reduced the interest rate subsidy. Interest deferral presumes continued enrollment on at least a half-time basis. There are also unsubsidized Stafford Loans that begin charging interest immediately with monthly payments starting immediately upon graduation.

Plus Loans are available to parents of dependent students, but 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. Interest rates are adjusted each year on the first of July. There is a 4 percent loan origination fee. There is no grace period and payments must begin within 60 days. Plus Loans as well as Stafford Loans have annual and total loan limits. The limits go up from second, third and fourth year students and some other criteria. 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. Calling them financial aid implies they have advantages or favorable terms to students and their parents that are not available elsewhere. Subsidy comes from a possible lower interest rate and from payment deferrals until after leaving school. Therefore the financial consequences of loans with different terms can be confusing.

The financial benefit of these loans varies but deferring monthly payments until 6 months after graduation is worth several thousand dollars of subsidy depending on the interest rate. A student who borrows $4,000 a year in interest deferred federal student loans will have $16,000 of debt six months after graduation. The monthly payment on a 10-year self-amortizing loan would be $184.13.

If 6.8 percent interest accumulation started immediately, student debt would be $19,543.74, which presumes yearly compounding and 4.5 years of interest accumulation. In that way, the federal interest subsidy is $3,543.74 on $16,000 dollars of loan principal. Monthly payments on the unsubsidized loans would be $224.91 instead of $184.13 on the direct Stafford Loan. With a little subtraction you can count your subsidy every month for 10 years.

The comparison above uses a 6.8 percent interest rate. The subsidy would be larger if the Stafford Direct Loan interest rate is lower compared to other market rates available. Of course, it is smaller the closer Congress sets the Stafford Loan rate to market rates. With the recent increases in 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 is also Hope tax credits and Lifetime Learning tax credits. These are explained elsewhere in College Corner at Tax Financing Help.