ABCs of Financial Aid

These days, it's hard to talk about college without mentioning financial aid. Yet this pairing isn't a marriage of love, but one of necessity. In many cases, financial aid may be the deciding factor in whether your child attends the college of his or her choice, or even attends college at all.

That's why it's important to develop a basic understanding of financial aid before your child applies to college. Here are some basics to help you get started.

What is financial aid?

Financial aid is money distributed primarily by the federal government and colleges in the form of loans, grants, scholarships, and work-study jobs. A student can receive both federal and college aid. An ideal financial aid package will contain more grants and scholarships (which don't need to be repaid) and fewer loans.

Financial aid can be further broken down into two categories: need-based aid, which is based on a student's financial need, and merit aid, which is based on a student's academic, athletic, musical, or artistic talent.

Need-based aid vs. merit aid

Both the federal government and colleges provide need-based aid. The amount of federal aid available in any given year depends on the amount appropriated in the federal budget, and this aid is spread over different financial aid programs. For colleges, need-based aid comes from a college's endowment, and policies may differ from year to year and from college to college, which may result in an uneven availability of funds. Colleges are the main source of merit aid, and they often use favorable merit aid packages to attract the best and brightest students to their campuses, regardless of their financial need.

The availability of college grant and scholarship aid tends to fluctuate from year to year and from college to college as schools decide how much of their endowments to spend, as well as the specific academic and extracurricular programs they want to target. As a family researching college options, one of the best things you can do to help your bottom line is to target colleges that offer significant grant and scholarship aid.

Every college offers a tool on its website called a "net price calculator" that you can complete to get an estimate of how much financial aid (need-based and merit) your child might be eligible for at that college based on your family's financial picture and your child's academic credentials. Net price calculators ask for parent and student income and asset information, and they take anywhere from 10 to 15 minutes to complete. It's a great idea to try out the net price calculator from several colleges to get an idea of what your out-of-pocket costs might be at different schools.

In addition to colleges, many businesses, foundations, and associations offer smaller merit scholarships. Many have specific eligibility criteria and deadlines. To find them, start with local scholarships (have your child check with his or her high school guidance office) and branch outward. Various scholarship websites allow your child to input his or her background, abilities, and interests and receive (free of charge) a matching list of potential scholarships.

How is need determined?

Financial need is generally determined by looking at a family's income, assets, and household information. The federal government and colleges have slightly different formulas for determining a student's financial need. The general process of aid assessment is called "needs analysis." Your current income is generally the most important factor in determining need.

The federal government's aid application is called the FAFSA, which stands for Free Application for Federal Student Aid. The federal government and colleges use the FAFSA when federal funds are being distributed (colleges are responsible for administering certain federal financial aid programs). The FAFSA uses a formula known as the federal methodology.

Colleges use one of two forms to determine how to distribute their own institutional aid. Most colleges use the CSS PROFILE application, while others use their own specific form. The PROFILE (or a college's own application) uses a formula known as the institutional methodology.

Under the FAFSA, your income and assets and your child's income and assets are run through a formula. You are allowed certain deductions and allowances against your income, and you're able to exclude certain assets from consideration, including retirement plans, home equity, annuities, and cash value life insurance. A full breakdown of the federal aid formula is beyond the scope of this discussion, but it generally works this way:

• Parent income is counted up to 47% (income equals adjusted gross income or AGI plus untaxed income/benefits minus certain deductions)
• Student income is counted at 50% over a certain amount ($7,600 for the 2023-2024 school year)
• Parent assets are counted at 5.6% (home equity, retirement assets, cash value life insurance, and annuities are excluded)
• Student assets are counted at 20%

The result is a figure known as your expected family contribution, or EFC. It's the amount of money that you'll be expected to contribute to college costs to be eligible for aid. Your EFC remains constant, no matter which college your child applies to. You can get an advance estimate of your EFC by using the federal government's online tool called the "FAFSA4caster."

Note: Starting with the 2024-2025 FAFSA, the term "student aid index" or SAI, will replace the term "expected family contribution," or EFC. The change attempts to clarify what this figure actually is: an eligibility index for student aid, not an exact dollar amount of what a family can or will pay for college.

An important point is that your SAI/EFC is not the same as your child's financial need. To calculate your child's financial need, subtract your SAI from the cost of attendance at your child's college. Because colleges aren't all the same price, your child's financial need will fluctuate with the cost of a particular college.

The PROFILE application basically works the same way. However, the PROFILE generally takes a more thorough look at your income and assets to determine what your family can afford to pay; for example, the PROFILE might look at your home equity or amounts you've contributed to medical and dependent care flexible spending accounts. In this way, colleges attempt to target those students with the greatest financial need.

Submitting aid applications

The best way to complete the FAFSA is to fill it out and submit it online at fafsa.ed.gov (it can also be completed manually and mailed to the address listed on the form). The online route is best because mistakes are flagged immediately and electronic FAFSAs take only one week to process (compared to two to four weeks for paper FAFSAs). To submit the FAFSA online, you and your child will each need to obtain an FSA ID, which you can also do online.

The FAFSA relies on income tax information from two years prior and current asset information (for example, the 2024-2025 FAFSA will rely on your 2022 income tax return). The FAFSA has the ability to directly import your tax information using the IRS direct data exchange tool, which is built into the form and is now mandatory. The FAFSA can be filed as early as October 1 for the next school year. The exception is the 2024-2025 FAFSA, which will be delayed until December 2023 due to an extensive redesign.

Private colleges typically require both the FAFSA and the standard PROFILE form or their own aid form, which you'll need to submit by each individual college deadline. The PROFILE form is generally submitted in late fall or winter, but is often required earlier if your child is applying early decision or early action. In addition to the form itself, the PROFILE will typically require you to submit tax returns, and possibly other financial documents, at a later date. If so, you'll receive instructions on how to do this.

After your FAFSA is processed, your child will receive a Student Aid Report highlighting your SAI; colleges listed on the FAFSA will also receive a copy of the report. Then, once your child is accepted at a particular college, the financial aid administrator at that school will try to craft an aid package to meet your child's financial need.

Comparing aid awards

Sometime in late winter or early spring, your child will receive financial aid award letters that detail the specific amount and type of financial aid that each college is offering. Colleges aren't obligated to meet all of your child's need. In fact, it's not uncommon for colleges to meet only a portion of a student's need, a phenomenon known as getting "gapped." If this happens to you, you'll have to make up the shortfall. On the flip side, if a college says it is meeting "100% of your demonstrated need," remember that the college is the one who determines your need, not you.

Read each award letter carefully and make sure you understand exactly what the college is offering. When comparing aid packages, the goal is to compare your out-of-pocket cost at each college. To do this, look at the total cost of attendance for each college and subtract any grant or scholarship aid the college is offering. If the grant or scholarship is merit-based, find out if it's guaranteed for all four years and what requirements must be met in order to qualify for it each year. If the grant or scholarship is need-based, ask whether you can expect a similar amount each year if your income and assets stay roughly the same (and you have the same number of children in college), and ask whether it will increase to keep up with annual increases in tuition, fees, and room and board.

The difference between the total cost and any grant or scholarship aid is your out-of-pocket cost or "net price." Compare this figure across all colleges. Once you determine your out-of-pocket cost at each college, determine how much, if anything, you or your child will need to borrow. Then multiply this figure by four to get an idea of what your total borrowing costs might be. Armed with this information, you'll be in a position to make the best financial decision for your family.

If you'd like to lobby a particular school for more aid, a polite email or letter to the financial aid administrator followed up by a telephone call is appropriate. Your chances of getting more aid are best if you can document a change in circumstances that affects your ability to pay, such as a recent job loss, unusually high medical bills, or some other event that impacts your finances. Your chances of getting more aid by asking one college if they'll match a favorable aid offer from another college is a less reliable strategy, but may be worth a shot if the colleges are direct competitors.

How much should I rely on financial aid?

With all this talk of financial aid, it's easy to assume that it will do most of the heavy lifting when it comes time to paying for college. But remember that all financial aid isn't created equal. Grants and scholarships are great because they are essentially free money. But loans are quite different. Parents and students who rely mainly on loans to finance college can end up with a considerable debt burden that can have significant negative implications for years after graduation. So aim to borrow wisely.