The Ultimate Guide to Paying for College

Paying for college is one of the most important and expensive decisions you will make with your child.  It is complicated and very emotional. To properly pay for college, the family must understand financial aid, college saving plans, educational tax credits, student loans, and student loan repayment.

As college cost and student debt continue to rise, families need to take a different approach to the college decision. More transparency and a better way to project the total cost is needed.

Listed below are the steps you need to follow to properly navigate this process.  It will help you utilize your college saving plans better and structure the student loan the best way.

Complete the FAFSA

The FAFSA is short for Free Application for Federal Student Aid. This should be completed by every family even if you do not think you will qualify for financial aid.  By completing the FAFSA this allows the family to structure their student loans better, show the college your ability to pay for college and qualify for need based financial aid.

The FAFSA process is also called the federal methodology. Any college or postsecondary education program that receives federal funds will require the student and family to submit a FAFSA form. This form must be completed for the student to qualify for any federal financial aid. The exception to this rule is merit aid, which can be granted without any financial aid forms submitted.

By completing the FAFSA form, the student will receive a number called their EFC or Expected Family Contribution.  The EFC number will be used to calculate a student’s financial aid package.

What Is An EFC?

The EFC or Expected Family Contribution is a formula used to determine financial health and assets. Many people mistakenly believe that the EFC is one number. The actual calculation is really four separate numbers that are summed together: parents’ income, parents’ assets, student’s income, and student’s assets. Each of these components has separate rules and allowances.

A family will get their official EFC by completing the FAFSA which generates a report called the Student Aid Report (SAR).  On the SAR report, the EFC will be listed as only one number. This process does not break out the four separate numbers. You need to understand the four quadrants of the EFC calculation to create a proper college-funding strategy.  The PayForED College Cost Analyzer provides a more detailed calculation.

By having four quadrants, better strategies can be created.  As an example, taking all the assets out of the student’s name may not matter if the parent’s portion of the EFC is higher than the college total cost.

Some colleges use an additional EFC process to confirm the assets of the family and it is called the Institutional Method. The Institutional Method will be completed as well as the FAFSA.   Most common is the CSS Profile which is managed by College Board. Many colleges with higher endowments use an institutional method.

Defining Your Academic and Financial Position

The colleges are masters of big data and have the goal of increasing the number of college applications each year.  They simplify the process to families by promoting how much financial aid was given out last year and give the suggestion that student’s need to apply to get access to these funds this year.  This is not always true. What is not explained to families is that each school has an average financial aid package which is never explained during your college visits.

The colleges use an approach called enrollment management.  This brings together a student’s academic position and financial position at a specific college in one place.  Many students understand their academic reach as it is often plotted in high school but they may have a financial reach that is never disclosed. This is a missing piece in the transparency of the college process.  Their financial reach will be determined by calculating the EFC and the school’s historical gifting.

By having both numbers, families can make a better college list and manage their expectations.

How Does Financial Aid Work?

Financial aid is used by the colleges to attract the students they would like to admit.  This is no different than a person or business. Each year colleges set goals which may change year to year.  For example, a college may want to increase the number of first-generation business majors for the school year 2019-2020.  Those students may receive more financial aid than other students that year.

Need-based financial aid is determined by using the college cost of attendance (COA), their EFC, and the college’s gifting policy.  Most colleges have a historic gifting policy which means they meet a certain percent of the need. Included in that percent of need is a certain percent of gift aid. This is where the financial aid gifting policy gets confusing.

COA – EFC = Financial Need

The Enrollment Management office brings together the academic goals of the college with the financial realities of those goals.  Each year that can be different, yet it is presented to families as a lottery system so that you may believe that they are trying to attract the best students.  That is not always true. The colleges are master of data and know exactly what they can do to get the class they want.

Types of Financial Aid

There are two types of financial aid; merit-based financial aid and need-based financial aid.  Sometimes it is hard to distinguish between the two when you get your financial award letter. If you’re uncertain, it’s best to contact the college and make sure you understand the details of the financial award letter.

Merit Scholarships

Merit-based financial aid is free money that is not determined by your financial aid position or EFC. This is considered a scholarship and can be awarded to a student for a variety of reasons, usually for academics or special skills that the student will bring to that college. Students normally receive a separate letter explaining the merit scholarship and the amount they will receive over the four years.

Most merit scholars have additional requirements attached to the annual renewal.  This could include a certain GPA, staying with that major, or a school activity. It is important that the student understands these requirements since if these are not maintained; the merit scholarship could be lost in total.

These scholarships reward students for their hard work and serve as an incentive from the college to attract the best students. As I described earlier, each school tries to create a certain class profile; colleges use merit awards to attract the students they want.

The merit-based process is extremely important for high-income and high-net-worth families. Merit-based aid may be the only way for these families to reduce tuition costs from the college. There are other ways to save money, but that money will not come from the college.

Need-based Scholarships

Need-based scholarships are a little different because it takes into account a student’s financial situation. From an admission standpoint, the college is still focusing on creating the ideal class profile. At the same time, that class profile needs to generate a level of income to pay the bills of the college. Most colleges face this dilemma when creating the best mix of accepted students.

I described earlier how the expected family contribution was calculated. The EFC is an important part of the need-based financial aid calculation. The first part of the need calculation is determining if you have a financial need at a college. If your EFC number is less than the COA number, you qualify for need-based financial aid.

Although the federal EFC is the same at each college, the need-based financial aid award could be very different at each college.  This is especially true when comparing a state school with a private school. This is where additional analysis is required since the private college may be able to provide additional financial aid making the net prices more comparable.

An overlooked factor in the need-based awards is it may change each year based on the student’s EFC.  The colleges only provide financial information one-year at a time. We believe a four-year or projection to graduation is critical but not often done.  This is an example of the lack of transparency and why student debt is rising at the rate it is increasing.

A way to avoid this is to build a family timeline and match it to a student’s EFC at each college.  By doing this a family is better prepared to see possible changes in their EFC which may impact their need-based financial aid.

Another section in the need-based financial aid section is called self-help.  This section includes different types of loans and work-study. It will vary by college and the amount of need each student has.  The self-help amount will normally need to be paid back or is money that is earned such as a work-study program.

For need-based students, a merit scholarship can be part of the entire financial award package.

Award Letter and Comparing Colleges

Award letters arrive and they may not all be in the same format or terminology.  This adds confusion to an already difficult decision. To understand the award letter, we suggest families review and understand the cost, scholarships, and loans that appear on the award letter.  If you have any questions, go back to the financial aid office of that institution to get answers.  To help you get started, we suggest you put your award letters in a standardized format and compare the cost of attendance, scholarships, grants, work-study, and loans.

Another important issue for families to determine if the family timeline both with the number of siblings in college at the same time and a determination of the number of years until retirement.  This will help a family when analyzing their cash flow.

Establishing A College Budget

Families need to create a funding plan or budget to make the best college decisions.  The first step for a family is to understand their cash flow based on the details of the financial award letter. In my opinion, the biggest weakness in the college-funding decision process is the way financial information is provided to families. Colleges and most families only look at the financial commitment on a one-year basis. This is a significant error but it is standard for award letters.

Creating a Four-Year College Plan

Creating a four-year cash flow by college is also important since it allows you to compare the true projected net cost of each college. This is especially true if you have multiple children in college at the same time, which could reduce your EFC significantly.  It may allow you to qualify for more need-based financial aid, resulting in a lower net price.

When you see the financial outcomes listed by college, you can more easily compare the other important aspects of the college decision, including the academic strengths and the environment of the colleges considered.

As an example, many private colleges meet a higher percentage of financial need, and a greater amount of that is gift aid. This can make a private college much more affordable than a lower-sticker-priced state university.

Of course, the financial side isn’t the only consideration. Some clients see that a state university is less expensive, but they feel that their child will not be able to learn in a larger academic environment. Parents and students need to focus on the outcome of education. This may include the learning environment and the cost of attaining a specific degree. When you factor in the graduation rates, retention, and possible additional financial aid, a private institution can offer a better value. You need to calculate the numbers to compare the real value and total cost of each college.

Student Loans

Another advantage of the four-year cash flow is that it enables you to see what debt will be incurred. Depending on a family’s financial resources and goals, how the money is borrowed will vary greatly.

Most families do not realize that students can borrow a limited amount under their name only. If they need more money to pay for tuition, a parent will need to take out PLUS loans or private loans. Most loans, other than federal direct student loans, will require the signature of the parent or another cosigner. Parents can also take out PLUS loans for their child, but these are the legal responsibility of the parent.

An important outcome of creating a four-year cash flow is identifying the years when additional resources will be required to attend that college. In most cases, a student and family will need to borrow to cover the shortfall. With the information provided in the ultimate guide for student loans, you can make better borrowing decisions, taking into consideration the various loan options and their advantages and disadvantages.

Student Loan Limits

It is essential that a family and student understands that the financial aid process has both academic and annual award limits each year for the federal student loan. For federal loans, this timeline is especially important to understand if your child transfers, drops classes or fails out a semester.

If a student transfers or fails several classes and does not maintain their same academic progress, it may reduce the amount available through the federal financial aid process.  These amounts are often prorated based on the student’s academic progress.

Part of reviewing your student loan limit necessitates the family reviewing their plan for paying for college.  Many families utilize federal loans to help supplement the cost of paying for college.  If this had been part of your strategy, then for the family with a transfer student may find essential to update the FAFSA with the new school.  Once submitted, the new college will recalculate the student’s eligibility based on the family’s financial information.

The family’s eligibility for federal loans will be the same if the student has maintained similar academic progress.  The institution scholarship money may vary significantly from the original award since this is from the college.  This analysis is why families should check with the new college to determine their policies and available funds before making a final decision.

Impact on Federal Loan Limits

As part of the transfer process, families will also have to review their current debt structure each year.  As stated there are specific limits to the federal loans that the student can obtain in their name with limitations based on year and the student’s academic progress. The student’s academic progress (SAP) is crucial since it will determine the student’s federal loan limit.

As an example, a student transfers to a new college after their freshman year.  They had received $5,500 of Federal loans for their first year of college.  The second-year federal loan limit for a dependent student is $6,500.  Due to the transfer, only 24 of the 30 credits were accepted by the new college.  As part of the SAP, the transfer student is not a full academic second student.  The $6,500 will be pro-rated down to reflect the missing six credits at this time.   Understanding the credit transfer is why it is essential for the family to understand the academically level once credits are transferred to the new institution.

Listed below is the loan limits per college academic year.

  • Freshmen Year Total $5,500
  • Sophomore Year Total $6,500
  • Junior Year Total $7,500
  • Senior Year Total $7,500

The important parts of the student loan decision need to include when the loan needs to be paid back, repayment options, interest rates, and legal responsibility of the loan.

Career Decision and Paying for College

As part of the college decision, the academic strength of the college should include the career or major the student is considering as a career.  This process needs to include selecting a major and possible career.  I suggest discussing the anticipated earnings upon graduation and the amount of education needed to attain that career.

This may seem harsh but the reality of the situation is that at some point the loans need to be paid back.  Finding the salary of the anticipated major helps the student get an idea of what their lifestyle may look like after graduation.  For the student loan borrower, now is also the time to review and estimate the number of student loans that will be needed over the next four years and longer if graduate school is a consideration.

Once the student has a rough estimate of their future salary, a quick calculation can be made to see if the anticipated salary will support the student loan payments on their projected debt.  Students often do not understand that their student loans have interest that will be added back into their loan total while they are attending college.

Loan Repayment Strategy

One-way students and parents can deal with the increasing cost of college are through the utilization of loan forgiveness and loan repayment programs. With these programs, some or all of a borrower’s debt will be forgiven if the repayment criteria are fulfilled.

Your career path is important in the strategy for repayment. Your career decisions have a significant impact on your financial future. As an example, a nurse may have the choice to work at a nonprofit hospital or in a private doctor’s office. This career decision will impact the loan forgiveness potential of that person. The nurse who works for the nonprofit hospital will qualify for loan forgiveness after 120 on-time payments while a nurse who works for a private doctor will not qualify for loan forgiveness until after twenty or twenty-five years depending on which repayment method he or she uses under current law.

Having a general understanding of your career direction will help you make better decisions about both loan forgiveness and repayment methods. As you can see with the example above, sometimes your career will dictate where you work. In other cases, you may have the freedom to select where you work to maximize the various financial options regarding loan forgiveness.