Student financial aid is money given by the Federal and State governments and the colleges to help students pay for the cost of a college education.

There are two basic types of financial aid:

1)      Self-Help aid which consists of interest subsidized loans and work study; and,

2)      Gift Aid, which consists of grants and scholarships.

The amount and type of financial aid is based on two factors:

1)      The merit of the student ( scholastic, athletic, musical, etc.); and,

2)      The financial need of the student. By far, this is the most important factor in determining financial aid. Most of the financial aid given by the Federal and State governments is based on the financial need of the student. Also, most of the financial aid given by colleges is need-based.

NOTE: The Ivy league colleges and other highly selective private colleges base almost all of their grants and scholarships on the financial need of the student and not the student’s merit.

So how is the financial need of a student calculated?

            NEEDS ANALYSIS is the process of determining the financial need of the student. It is calculated using the following formula:

                              COST OF ATTENDANCE (COA)

-          EXPECTED FAMILY CONTRIBUTION (EFC)

=    FINANCIAL NEED

-          RESOURCES OF THE STUDENT

=   ADJUSTED FINANCIAL NEED

EXAMPLE: If the ‘cost of attendance’ at a particular college was $12,000 and the ‘expected family  contribution’ was calculated to be $4, 000, the ‘Financial need” of the student would be $8, 000. In this case the student would be eligible to receive $8,000 in financial aid. Whether he receives a financial aid award for the entire $8,000 is up to the discretion of the individual college. Nonetheless the financial aid eligibility of the student is directly related to the financial need. If the student, had other resources to help pay for the college cost, the financial need would be reduced on a dollar-for-dollar basis for these resources. In this example assume the student had received a $1,000 private scholarship from the local Chamber of Commerce.  Since private scholarships (scholarships which are not given by the college), are considered a resource, the  $1,000 scholarship would reduce the financial need down to’$7,000. This means the student would now be eligible for only $7,000 in financial aid from the college.

This time of year, students and families are pondering the loan question.  The fact of the matter is, most students will have to finance some or all of their education.  The College Board provides the following tips when considering student loans. 

1. Look at your child’s award letter and figure out which need-based loans your family has been given and for what amounts.
2. After you look at your family’s full financial picture—education cost, awarded aid, and family share—settle on the amount you or your child actually need to borrow.
3. Never borrow more than you need. Remember, you are not required to borrow the full amount of loan aid your child has been offered or to borrow the maximum loan amount.
4. Don’t forget about student employment as an alternative for borrowing. Although working at a job can seem like an extra burden for your child, so is struggling with high loan repayments after college.
5. Apply for your loans right away. You want to make sure that the loan is approved and the money paid to the college before your family has to make your child’s first student account payment.
6. Follow the loan application instructions carefully. Any mistakes you or your child make will delay receipt of the funds.
7. For a Stafford Loan, be prepared for the amount that is paid to the college to be less than the amount for which your child signed. An origination fee, guaranty fee, or both, may be subtracted from the loan before the check is sent to your child’s college.
8. If you will be taking out parent loans, start to keep track of your “loan tab”—the amount your monthly repayment will be—once you know the amount that you are borrowing.
9. If you feel your family needs to borrow more than the amount that’s been offered in your child’s award letter, talk with a financial aid counselor before taking on an additional loan.
10. If you or your child does take on an additional, unsubsidized loan, consider making interest payments while your child is in school. They won’t be much and will save you money—you’ll end up having to pay back significantly less than if you delay (and capitalize) the interest payments.

Deciding which loans are best for the family depends on these different factors:

1  Who will repay the loan

2  Repayment terms

3  Tax bracket

4  Cost of getting the loan

There are two loans the dependent student is legally obligated to repay: the Stafford and the Perkins loans. Any other loans are the parents’ responsibility unless they have jointly co-signed a private loan from a commercial lender.

Federal Loan Programs

These are the Perkins, Stafford, and PLUS loans, all of which have very good repayment terms and interest caps. Currently the repayment period for federal loans is 10 years.

Here is what the monthly payments would look like:

Besides the standard payments available, there are other repayment options available. The family can consolidate loans and stretch payments out over 20 years. There are graduated repayment plans which have smaller payments in the earlier years and gradually increase over time (these have higher interest costs).  Income contingent plans base the amount of payment on the level of income of the student after graduation. As income rises or falls so does the amount of payment.

Home Equity

Another viable alternative is a home equity line of credit where the family borrows only what they need, when they need it, paying interest only on the amount that’s borrowed. There is a minimum monthly payment, and the interest is normally tax deductible, but also variable.

*Make sure to compare the benefit of a federal loan vs. a home equity line of credit.  For example, a federal loan at 6% is equal to an equity line at 8.3% for someone in the 28% tax bracket because of the tax deductible nature of the equity line interest.

Second Mortgage

With a second mortgage a fixed amount is borrowed, and there is generally a fixed interest rate and repayment schedule. While it provides for a more consistent budget plan, the family is paying interest on money before it’s needed and have higher payments before it’s necessary.

401(k)

In some cases borrowing from the parents 401(k) retirement account is

possible. There are federal limits on the amount that can be borrowed.  Also,

the loan must be repaid in 5 years or stiff tax penalties apply as it becomes reportable as a premature distribution if the owner is under 59 ½ years of age.

Life Insurance Policy

Borrowing against the cash value of life insurance policies is another option. The repayment terms are often very lenient and may provide the option to only repay the interest. The loan may affect the death benefit and the interest rate earned by the remaining cash value.

*Remember that with every loan there are processing fees. These charges should be considered as well when comparing loans.