Merit and need-based aid are the two major types of college funding that do not require repayment. Understanding the difference between them can save a family time and money, and help with college selection. This knowledge also helps a family save on the cost of college. As you know, we have been reviewing and discussing three aspects of creating a college funding program: saving for, shopping for, and saving on the cost of college. Saving for college employs a combination of 529 accounts, taxable accounts in the parents’ and/or child’s name.

Shopping for a college means finding the right fit academically, socially, and financially. Parts of the social and academic apply to the financial side. For example, a student’s GPA and test scores may help qualify him or her for a scholarship. The social component may have added costs, such as fraternity or sorority dues. Other types of clubs may be free. A family must also know how much it can afford to pay before the child attends a higher education institution. In performing this first task, feel free to download my college funding snapshot report. This report offers insights into the current funding status of the student’s higher education.

Saving on the cost of college means understanding the resources beyond savings that you can use to create price breaks. We typically call this bargain hunting or smart shopping to ensure you do not overpay. For example, while looking for deals online, you likely have come across a promotional code to receive a discount on a product or service. Perhaps while buying your last vehicle you received a rebate or 0% financing. You should pursue saving on the cost of college with the same vigor and skills. One way to create a price break for college, as mentioned before, involves merit. A second way to create a price break bridges shopping for college by strategically applying to universities with favorable need-based practices.

Understanding Merit-Based vs Need-Based Financial Aid

 

What is merit-based financial aid?

Merit-based aid is money based on something other than financial need. We often hear about sports or academic scholarships. For the latter, students must commonly maintain a minimum GPA. To qualify for the academic scholarship, the student must typically have met certain academic standards. An example may be a school that gives an automatic scholarship to students who earn a minimum SAT/ACT score with a certain GPA upon high school graduation. Other times, students must write essays or participate in civic activities or interviews. For more prominent universities, the student may have to provide a combination of all these.

As the definition suggests, merit-based money may be awarded for many types of actions. When considering merit aid, a family must be aware of a few things. If the scholarship is private, is it a one-time payout? How much effort will the student be exhausting for the scholarship? For example, if two scholarships are under consideration and require equal amounts of effort, students should apply for the higher payout. For multiyear scholarships, what standards must be met? If the student does not finish his or her degree or meet the standards, will the student be required to pay it back? Families may want to consider scholarships that “prepare” a student for the college application, which may require an essay. Specifically, does the scholarship essay ask the student to state what makes him or her different and the best fit? The student may be able to use this material later for the application essay. Make changes to fit the specific need; the more the student tells his or her personal story, the stronger his or her confidence will become and the more easily he or she will be able to tell the story in the future. This also creates efficiencies in the application process for other scholarships and college applications.

Merit aid may come packaged in a few ways. The first is a competitive scholarship. Here, students compete against one another in a range of areas, including interviews and essays. The second merit aid is more like a grid of test scores and GPA. If you earn a certain score and graduate from high school with a certain GPA, you may receive the funds automatically. Following is the merit scholarship from Miami University.

The last form of merit aid is a package from the university. Here, the student may receive funds based on a combination of factors, like extracurricular activities, interviews, GPA, and test scores.

A merit-based conversation would not be complete without a discussion of sports scholarships. I left these out for two reasons. First, many parents expect their children to receive some type of aid if the student was a better player on his or her sports team. However, the numbers don’t bear this out. Eight million high school athletes compete each year in the United States. Only 480,000 of those athletes will compete on a collegiate level (1.). That means roughly 1 in 16 high school athletes will compete at this higher level. Further, only 150,000 students in Division I and II schools receive athletic scholarship offers. Even then, they may not be full rides, leaving parents and students with some out-of-pocket costs. Division III schools do not give out athletic scholarships. However, it is not uncommon for a small group of student-athletes to receive some other type of merit-based aid.

What is need-based financial aid?

Need-based financial aid reflects the student’s and family’s ability to pay tuition. This does not stem from anything other than financial need. The driver for need-based aid directly reflects the basis college funding formula.

Cost of attendance – Expected Family Contribution (EFC) = Need

If you recall from my other article outlining the EFC, this is what the government thinks your family may pay based on the student’s income and assets as well as the parents’ income and assets. Typically, the largest driver in the EFC is parental income. Decreasing the EFC is one way a family can try to increase need. A second and often overlooked alternative involves increasing the cost of attendance. Typically, this involves bringing out-of-state state schools and private schools into the picture for consideration. On a side note, more out-of-state schools are offering in-state tuition prices for neighboring states. For example, I learned that several Ohio universities, both private and public, were offering in-state tuition to incoming Indiana students. A later blog post will provide more details about this pricing reciprocity.

Remember, you are trying to get the lowest net price possible. Combining the EFC and attendance strategies may be another option. However, most upper-middle-income families do not consider these tactics because they do not fill out the FAFSA or CSS, which also serves as an application for many school-based grants and scholarships.

Understanding merit-based and need-based aid does not stop here. Families must also understand the differences between institutional and private scholarships

Private and Institutional Scholarships

One of my favorite activities is fly fishing. Admittedly, I am not good, but the simple act of casting a line over moving water with a smooth movement of the rod back and forth is beautiful. I make a few special trips each year to earmarked locations simply to engage in this activity. The experience creates the proverbial fishing stories we hear, tell, and share with friends. In my case, though, I can count on one hand the number of fish I have caught with a fly rod.

What does this have to do with scholarships? It seems that families have the same experience with scholarships. We hear and share stores about the “big money” given to the boss’ nephew’s daughter, or maybe our student even gets a few scholarships himself or herself. Often, it will be a few one-time hits for a few hundred to a couple thousand dollars from a specific nonacademic source, like a community foundation or business. These nonacademic sources provide private scholarships.

Institutional scholarships are given through the big players, like universities and the government. In fact, undergrads receive a much higher dollar amount from institutional money than from private scholarships.

I make this point not to say that private and employer-based grants are not important, but rather to explain where the large pool of money sits. Back to the fishing analogy. If I want to catch several fish, I should stop using my fly rod and instead fish with a stick of dynamite. Families may gain more aid money for their efforts if they refocus on where the large pool of money sits.

An important side note: If your family plans to use a college financial aid company or individual, make sure you understand what they are providing. Last year I attended a seminar that promised to get my daughter scholarships and get her into “great institutions.” However, the burden of the work for getting the scholarship still rests on the student’s shoulders; the aid company may simply screen for scholarships for which they suggest the student apply. The student must still write the essay. Some free sites match the student and the scholarship opportunity. Many of the best opportunities come from specific scholarships at the school. When you are shopping for schools, it is a good idea to ask about grants and aid at the university and department levels.

Merit vs. Need Tendencies

Colleges often favor one form of merit or need-based financial aid. Knowing how your prospective school favors aid will help you create a college funding strategy. Let’s take a look at two examples.

The University of Notre Dame has 100% of financial need met, with 79% of the funds coming from scholarships and grants and the remaining 21% coming from loans and/or jobs. Miami University meets only 59% of a student’s financial need, with 59% coming from scholarships and grants and 41% coming from loans and/or jobs.

In a nutshell, Notre Dame focuses more on meeting the student’s financial need while Miami seems to focus on the grid system. Does this make Notre Dame better? No; the two universities simply take a different approach to scholarships.

How do I take advantage of need-based or merit-based financial aid?

Hopefully, you have picked up on the fact that most schools lean one way or the other in dispensing financial aid to students. Families should become familiar with where the schools on their list lie. The best way to perform this task is to lay out a grid for the student as a means of understanding where to focus.

It is not enough to say that a school leans more toward merit or need aid; after all, the student will be the one attending school. A family’s best aid option does not lie on a clear path. Rather, a continuum exists. Income shows the point. The parent’s income will most likely be the biggest driver in controlling the Expected Family Contribution or EFC. We know families make $0 to millions.

The continuum exists on the GPA and test side of merit aid. There is no pass/fail.

The best way to understand where a school sits is to create a grid style of analysis, like the one below.

Start by asking, “Where does the student fall on the chart?”

Are you high need and high merit (quadrant II)? Or maybe low need and low merit (quadrant III)? This will in large part determine the tactics you can leverage to help with your college funding.

An example

Let’s imagine we have two students, Jonny and Suzy. Suzy was diligent in keeping a high GPA, was part of the band, and joined a few clubs to round out her extracurricular activities. She also scored well on her SAT. Jonny was not as active and did not keep a high GPA, nor did he score well on the ACT or SAT. As you can see, we have a high-merit student and a low-merit student.

Let’s further assume that Suzy was raised by a single parent who worked three jobs to make ends meet. Jonny’s parents work in middle management at the local Fortune 500 company, making at least $100,000 each.

Now we know where each student lies. Suzy will be in quadrant II as a high-need and high-merit student. Jonny will be in quadrant III as a low-need and lower merit student.

What comes next?

Each student should continue plotting his or her list of schools on the graph. Do the schools meet a high percentage of need? What about merit? Students should take note of the schools located in their quadrant. While acceptance is not guaranteed, these schools will likely be the easiest for the student financially.

While we have clearly divided the graph into quadrants for discussion purposes, a fuzzy divider exists as you move from one quadrant to another. Students and families must ask the following two questions:

– Which factors move the student around in the quadrant the most?

– Which levers must we pull to get us closer to the school we want?

The first question identifies those factors on which a family may work to improve its college funding plan. The second question introduces action the family can take to move the student to a better position relative to the school.

Let’s get back to Johnny and Suzy.

With Johnny being in quadrant III, he can focus on selecting a favorable school, getting a higher test score, and receiving “tax scholarships.” The latter point means using the tax code to find funds that help pay for school. The two most common examples are the state tax benefits provided by contributing to a 529 and the American Opportunity Tax Credit (if the parents qualify.) Selecting favorable schools means paying more attention to the choice of in-state vs. out-of-state and public vs. private. Price will be a bigger factor. The last component, higher test scores, helps the student work on merit. Not all scholarships are given to high-merit students, but higher test scores help as the university seeks to bring in the best freshman class it can; test scores are a key ingredient for creating a great incoming class.

Suzy, being in quadrant II, has many alternatives. High need means focusing on those schools that meet a large percent of the need. If Suzy and her mom can get the Expected Family Contribution down even lower, her need increases. Lowering their EFC may be another way of helping with college funding. Merit money based on GPA and test scores open the door to those schools that provide merit-based aid. Working on her test prep to gain a few extra points on the SAT/ACT may mean thousands of additional dollars in institutional aid.

The small difference each student makes in his or her plan can yield larger cumulative savings and cost reduction.

Have questions about where to start your college funding plan? Download the College Funding Snapshot Report and watch the video on how to effectively use it.

Sources

1.http://www.ncaa.org/about/resources/research/probability-competing-beyond-high-school

– https://meritscholarships.nd.edu/

– http://miamioh.edu/admission/merit-grid/

Can you imagine wanting a car and heading to the dealership located close to where you typically park, then seeking acceptance from your friends and family for your purchase? This seems like a ridiculous way to buy a car, yet this is exactly how most families approach higher education. Most families select a college based on location and flash when other important factors should drive the selection.

As college consumers, we must change the way we approach higher education. Families must save for, shop for, and save on the cost of college. So far in our series, we have talked about saving and covered information about shopping for college. Saving for college means starting as soon as you can. Accounts like the 529, custodial accounts, and taxable brokerage accounts in the parent’s name help satisfy the saving portion. As we know, shopping for college occurs when the student is close to the age of 18 and means developing a budget so you know how much you and your student can spend on higher education.

Shopping for a school also means knowing the best fit for the student socially, academically, and financially. These are important characteristics because they will ensure a better fit, thereby resulting in more happiness and satisfaction and a lower cost. However, many families don’t properly consider these characteristics, which results in longer academic careers, higher costs because of the extended time at school, lower satisfaction, and missed income from the student not working.

How we pick a college

Most students choose a college that is within a few-hour drive from home. When families tour colleges, the larger names spend large amounts of money to create a warm, glowing front. Admissions counselors tour the state or region, attending college fairs to attract the next freshman class. We can’t forget about sports; how often do we hear a university’s name for the first time during a sporting event? Think about the NCAA basketball tournament and the big names – and the “Cinderella” teams that rarely take part. The point is, the flash mentioned earlier is all around; reputation is a big factor in choosing a college. The reputation may be for academics, research, sports, or partying.

For those families that do a little more research, popular rankings like the US News and World Report one become a common tool. However, the question remains: Do these rankings correlate with success and better well-being after college? In a 2012 blog post (link to the post), a popular college admissions expert, Lynn O’Shaughnessy, notes: “Unfortunately, the methodology fueling the rankings are a collection of subjective measurements that students and families are supposed to rely upon to pinpoint the schools doing the best job of educating undergraduates. U.S. News relies on proxies for educational quality, but these proxies are dubious at best.”

She goes on to note four ways in which the rankings hurt students and parents.

– Rankings encourage the college to favor well-off students.

– Rankings encourage admissions tricks.

– Rankings encourage cheating.

– Rankings encourage debt.

Breakthrough

Over the past few years, researchers have made breakthroughs that can help families make better college selections. Two research powerhouses, Gallup and Purdue University, developed an index. The two institutions joined forces to “respond to increased accountability among higher education institutions… (to provide) insight in the relationship between the college experience and whether college graduates have great jobs and lives.”

After all, isn’t this what we really want for our children? As parents, in selecting a college, we lose the forest for the trees; we get bogged down by the “flash” of an institution and overemphasize unimportant characteristics such as the school’s reputation or sticker price (not to be confused with the price that families end up paying).

How did Purdue and Gallup help?

The Gallup-Purdue Index was the result of interviews of more than 30,000 college graduates from all over the nation. From research already completed by Gallup, we know that having a good job is an important factor in life (1-p1.), as it provides a mean of establishing one’s self-identity. The study focused on the well-being of the interviewees.

Well-being, according to Gallup, builds on five elements (1-p2.).

Purpose Well-Being: Liking what you do each day and being motivated to achieve your goals

Social Well-Being: Having strong and supportive relationships and love in your life

Financial Well-Being: Effectively managing your economic life to reduce stress and increase security

Community Well-Being: The sense of engagement you have with the areas where you live, liking where you live, and feeling safe and having pride in your community

Physical Well-Being: Having good health and enough energy to perform one’s daily tasks

As mentioned before, 30,000 college graduates from many types of colleges and universities were interviewed.

Factors in choosing a college

The study produced interesting findings. Whether a college was public or private, large or small, selective or not – none of these traits mattered more in terms of well-being or work life than the worker’s experience in college. Among the study’s other important aspects was the revelation of six factors that lead to increased well-being (1-p4.).

1. When a student feels like a professor cares about them as a person.

2. Having a professor who makes a student feel excited about learning.

3. Having a professor who encourages students to follow their dreams.

4. Having an internship or job where the student applies what they were learning in the classroom.

5. Involvement in extracurricular activities and organizations.

6. Working on projects that took a semester or more to complete.

The higher the number of these factors students experience in college, the greater their engagement and the likelihood that they maintain overall well-being.

Factors vs. traditional college selection

As you can see from the traditional way we select colleges versus the use of a factor-based approach, the student will likely end up in a better situation in the long run. The process for college selection evolves to become more objective or straightforward. However, a factor-based approach does not mean the student will graduate without debt or will not experience any of the questionable practices of a higher education institution.

Rather, using a factor-based approach helps a family and student identify the key characteristics to look for in a college as tours and research accumulate. The student should also start by answering the following questions: Do I want a small or large institution? Do I want an institution focusing on faculty research or undergrads? Are sports important me? How far away from home am I willing to go? Do I want a technical or liberal arts education? These questions will help narrow the focus and achieve the best fit for the student.

Where can I find information related to these factors?

Ratemyprofessor.com– Here you can find information about specific professors based on the student’s perspective. Here is a snapshot of Ball State University on the university level. Notice the clubs and opportunity ranking. This may help you make evaluations based on factors four, five, and six listed above.

Niche.com– This site also grades a university, according to the categories shown below. The professor rating helps with evaluating factors one and two. While not isolated, this still gives prospective students something to consider.

 

Collegedata.com– Hidden among the data is a section under the Students tab called “After Graduation.” Here, the viewer will see a percentage of graduates who have a job offer within six months of graduation. When looking at placement data, one should keep two items in mind. First, data can be manipulated. This was hinted at earlier in Lynn’s article, and the Hechinger Report covers this topic in more detail. (http://hechingerreport.org/placement-rates-data-colleges-provide-consumers-often-alternative-facts/). Second, majors affect placement rates.

 

College-bound next steps

1. Work on answering the questions posed about the type of institution first.
2. Compose your list of schools.
3. Use the resources listed here to help compare the universities based on the Gallup-Purdue Index.
4. Find out how much you can afford to pay for college.

Do you like this article? Please share it with other families that might find it useful.

Want more? Subscribe to follow this blog or check out my YouTube channel: https://www.youtube.com/channel/UCgYzBd7iIdkFdwyosJLG–A?view_as=subscriber

Sources

1. 2014 Gallup-Purdue Index Report
2. http://www.thecollegesolution.com/how-u-s-news-college-rankings-hurt-you/ (access 1/12/15)

The last article focused on step two of the college funding process. It reviewed the types of student loans and broke them down into federal and private loans, as well as the subcategories of student and parent loans. Today, we continue by discussing student loans and the student loan crisis. Will there be a crisis or is it already here? What trends are taking place with student loans?

Funding College with Student Loans

Seven out of ten families will use some form of student loans to help pay for college. Many families accept this statistic as a normal part of sending a student to school. Some families see the current debt load of $1.4 trillion and focus on creating a lower or no-debt funding plan. The goal for later families is to help control early expense risk (increasing needed cash flow to duties that do not normally exist). With few or no student loans, young workers can save for retirement, a house, a baby, or other goals.

Problems do exist for students who have student loans and no degree. A worker with a college degree earns more over a lifetime than does a person without one. Imagine how much further behind a college drop will be when student loan payments enter the equation. Not only will this person earn less, but his or her expenses will increase.

Government Limiting Risk

As strange as it sounds, we can thank the government in some way for helping limit the expense risk that students face – specifically, those students who did not earn degrees. You may recall from the post Different Types of Student Loans that the federal government limits how much a student can borrow based on his or her year. Freshmen can borrow $5500, sophomores can borrow $6500, and juniors and seniors can borrow $7500. The caps limit risk by not letting underclassmen take out too much in federal student loans.

These limits make sense when one considers the high number of students who drop out of school. In risk management, this would be an example of risk reduction. The student’s risk of default does not go away but rather is limited to the lower amount of the Stafford loan. In terms of other types of student loans, this trend moves in the opposite direction. A quick review of the data below shows the point.

Notice the 25% growth in Parent PLUS loans and the almost doubling of the nonfederal loans? These are the loans that start getting families in trouble, which begs the question: How does this happen after more than a decade? After sitting by some of the families and helping them fill out their FAFSA forms this fall, I have no doubt that the process of going to college creates large amounts of stress for the student and the parent. Many feel that completing the FAFSA is not only harder but more stressful than completing their tax return.

When families receive their acceptance letters and aid packages, the sense of relief overcomes them and they pay little attention to the financial aid package. As consumers, we must keep in mind that these non-friendly loans become collateralized with Mom and Dad’s names or assets. Bankruptcy does not necessarily dismiss the debt, either.

Here we sit, in $1.4 trillion of student loan debt.

Student Loan Crisis

When do you call something a crisis? Is it after we push the ball off the cliff, or just before the tipping point of going over the cliff? Experts disagree on the answer, and some contend that a crisis does not exist. However, we cannot dispute the data. The following graph shows a different story (1.)

Nearly one-third of the federal education loan portfolio is in deferment, forbearance, or default. Not all delayed payments under these programs are negative. A student may qualify for a deferment for several reasons, like active duty, military service related to a war, a military operation, a national emergency, or enrollment in an approved rehabilitation training program for the disabled (2.). Other scenarios may qualify a person for deferment.

Simply looking at the default rate should make us uncomfortable. Mortgage delinquencies during the great recession topped out at 10.53% (3.). We are sitting at nearly the same rate on student loans. The public keeps sloughing off the concern. Major ramifications will likely result if the default rate continues increasing, which may drag on for some time. As mentioned before, student loans typically cannot be written off in a bankruptcy. Banks wrote off the bad mortgages from the Great Recession. For capital markets to work efficiently, this write-off process should be short. The markets then quickly adjusted to reprice the mortgage. The default of a student loan has the potential to go on for years or maybe decades as long as the borrower remains alive. Markets cannot be efficient with the current state of affairs, and inevitably delays the likely result of not recovering the principal amount of the loan.

Possible Crisis Scenarios

You know from my other posts that student loans have a negative effect on the individual. For example, when families have student loans, they save less for retirement and delay having children. Blow this effect up nationally and imagine how things change. The question to answer is: How do student loans with extended defaults affect spending and economic patterns?

What if it was easier to declare bankruptcy on student loans?

Perhaps the financial markets would be able to absorb the disruption more quickly than forcing a delay and extended process for dismissing the debt. Of course, the normal and negative side effects would accompany the dismissal. The family/individual would be able to move forward more quickly. Today, the issue is politicized, with no progress made in terms of reform or in the ability to dismiss the debt. The courts still use a standard – called the Brunner test – established in 1987 (4.).

Even debt holders using income-based-repayment plans face some economic challenges. By dragging out payments over 20 or 25 years, the worker pays more interest, which is not going toward other desired outcomes that contribute to current or future economic output. To put it another way, more dollars are spent on the past than on the present or future.

The current system has produced no significant changes. As mentioned before, debt has increased at a ridiculous rate. A rising interest rate environment creates a squeamish outlook for students who take out future loans and for those who hold variable rate loans.

Perhaps a different form of “forgiveness” should be reviewed, or we should let the markets help decide the fate of delinquent loans.

Next Step:

If your student is college bound, take the first step and create a college funding budget. Consider it the rudder on a ship; it will provide direction and prevent your student from facing the student loan crisis problems that this post has outlined. Second, create a smart lending strategy. This means knowing the rough starting salary of your career. The student should not graduate with more in debt than his or her first year’s salary. Shop for a school that meets the needs of your student socially, academically, and financially.

For those in school, take the time now to estimate the debt you will have accumulated upon graduation. Will you be eating ramen noodles or living the way you expect? If the former, make changes now to limit the damage. Take on a shift at a local business or at school. Do not borrow money for spring break trips. Take more credit hours or go to summer school so that you do not extend your academic career by another year or two.

Before your student heads off to college, make sure you know how much you can afford by using the free College Funding Snapshot Report.

Have questions? Call me at 317-805-0840 or email me at ncarmany@thewatermarkgrp.com.

Sources:

1. Trends in Higher Education Series. PowerPoint. 30, October 2017.
2. https://studentaid.ed.gov/sa/repay-loans/deferment-forbearance#deferment-eligibility
3. https://fred.stlouisfed.org/series/DRSFRMACBS

http://www.studentloanborrowerassistance.org/bankruptcy/

A great college funding plan considers the different types of student loans and has three steps. The first step sets up your resources and budget. The last blog post focused on this topic. We reviewed how to create a college funding budget and compared it to the pre-approval process of buying a home. Also, the post explored the different funding categories. Loans made up two of those categories – one for parents and one for students. The second step in your college funding plan creates a smart lending strategy so the student or parent does not create a future financial burden. The last step is to shop for college. We will study this topic in later posts.

Today, we focus on the second step by examining the different types of student loans. As mentioned in other works, there are two major categories of student loans: federal loans and private loans. Each category may break down further into student or parent loans. Student loans refer to debt that is in only the student’s name. Parent loans may be in the student’s name but the parent acts as a co-signer, or the loan may be in only the parent’s name.

FEDERAL LOANS

Stafford loans are the most common type of federal student loan. These loans will be either subsidized or unsubsidized. Among the loans, three differences exist: 1. The government pays the interest on subsidized loans while the student attends college. 2. The eligible amounts for subsidized loans are lower than those for unsubsidized. 3. A student must qualify for the subsidized loan, while every undergrad student is eligible for the unsubsidized loan. The student qualifies for subsidized loans by demonstrating financial need. To put it in a simple math formula (1.):

Cost of Attendance – Expected Family Contribution = Demonstrated Need

As you saw in my other post about expected family contribution, calculating this number is anything but easy. However, from the formula above, you get the basic of idea of how to qualify for subsidized Stafford loans. The government manages the amount it will cover in loan interest by limiting the amount of the subsidized loan. Depending on the amounts, a student may borrow the following under a subsidized loan: $3,500 for freshmen, $4,500 for sophomores, and $5,500 for juniors and seniors.

As mentioned earlier, every student qualifies for unsubsidized loans. The dollar amount a student may borrow depends on the grade level: $5,500 for freshmen, $6,500 for sophomores, and $7,500 for juniors and seniors. With this type of loan, the interest starts accumulating at the loan’s origination.

The two types of loans may be used together but the amount borrowed in any one year should not exceed the higher limit of the unsubsidized loan. If a student qualifies for subsidized loans, this will be used to the maximum first; then an unsubsidized loan will be added to the amount and not exceed the limit. Interest rates are fixed for the life of the loan and reset for new loans every year.

Perkins loans are another type of student loan that may be used. They are low-interest loans for grad and undergrad students who demonstrate exceptional financial need. The school is the lender and payments are made to the school or its service provider. Not all schools participate in the Perkins loan program, and funds may be limited (2.) Students with a high need should check with the school’s financial aid department for participation details. This loan program is not as popular as Stafford loans.

Parent PLUS

Parents may help students pay for college using a Parent PLUS loan. Parents of PLUS loans may acquire loans for dependent undergraduate loans (3.) These loans are not accessible to other students, namely graduate and independent students. Divorced parents may both acquire loans, but the total between them cannot exceed the loan limits (3.)

The total amount that parents may borrow for any one year follows the formula below:

Full annual cost of attendance – other financial aid the student received = Potential PLUS loan

Parent PLUS loans require no debt-to-income ratios and are not dependent on the borrower’s credit score (3.) As a result, the interest rates on these loans are rather steep. The current interest rate for the 2017-2018 academic year is seven percent with a 4.264% origination fee, making the real first-year rate for the loan 11.264%. As you can see, this high rate can quickly put families in trouble. Now just imagine the problems faced by families that take out these loans year after year.

Repayment of the loans typically starts 60 days after the loans are fully dispersed (3.) However, loans after July 1, 2008, can be deferred while the student attends school at least half-time (3.) The standard repayment applies to a 10-year repayment schedule. Income-based repayment schedules typically cannot be used with Parent PLUS loans, but they are eligible for student loan forgiveness (3.) PLUS loan consolidation cannot be done with other federal loans in the student’s name.

To apply for PLUS loans, parents fill out the FAFSA, then request the loan through StudentLoans.gov. You can also contact the financial aid department of the student’s college or university.

Private Loans

Private student loans vary greatly in terms, payment provisions, and features. For the most part, private loans lack many of the common features of federal loans, like fixed interest rates and income-based repayment plans, and are not subsidized (if you qualify). Most private student loans are issued by banks, credit unions, state agencies, or even the schools themselves.

Many private loans require repayment while the student attends college. Some of these loans require an established credit history or a co-signer (often the parent). Student loans commonly use variable rates. If interest rates rise, the loans become more expensive. Additionally, the loan may not be consolidated into a Direct Consolidation Loan and it may not have forbearance or deferment options.

In general, private loans do not compete with the flexibility or features of most federal loans. However, private loans constitute one of the fastest growing types of loans. See the graph below.

 

As noted above, the federal government limits the amount a student may borrow in Stafford loans. The price of tuition continues to rise year after year. As a result, programs like Parent PLUS and private student loans experience large growth.

Summary

Many graduates to wonder how they will pay back their complicate and confusing student loans. As we saw, student loans divided into federal and private loans and further split into parent and student-only loans. Federal loans give the borrower attractive terms as compared to private loans in general.

Student loans are the focus of the second step in creating a smart college funding plan. The student and family should know how much they can afford if the college budget is established up front, thus reducing the number of surprises upon graduation.

Coming Up

The next post discusses paying back student loans. It starts with a smart lending strategy.

 

Sources:

1. https://www.edvisors.com/fafsa/estimate-aid/financial-need/
2. https://studentaid.ed.gov/sa/types/loans/perkins
3. https://www.edvisors.com/college-loans/federal/parent-plus/introduction-to-federal-parent-plus-loans/

In this video, we talk about the recent tax reform, 529 accounts, and how it may not be as great over the short term as people hope.

Topics:
1. Provision of the tax from allowing families to withdraw $10,000 for private tuition.
2. Tax treatment of 529 on the federal and state level.
3. States playing catch-up to the tax reform.

As always, check out collegeandretirementplan.com for more information or email me at ncarmany@thewatermarkgrp.com.

 

Planning for college gives families the opportunity to send young adults into the world on the best footing. Not only do these young work warriors learn technical skills to follow a career with a livable income, they also learn social skills by interacting with a new set of people. When not carried out properly, students and parents often see the end of academic careers with debt and no diploma. Creating a better understanding of how college funding works and the choices that are available help parents in the process of saving for, shopping for, and saving on the cost of college. This post will act as an introduction to saving on the cost of college, with a review of the family’s expected contribution.

First, let’s take a step back and look at the landscape as it exists today.

Google “student loan debt” and a barrage of articles and statistics fill your search results. As most families with college-bound students know, total student loan debt is well over $1 trillion. In fact, the most recent numbers show total student loan debt at $1.4 trillion (1.). In 33 out of the last 35 years, the cost of college has risen faster than the pace of inflation (as of October 2016) (2.)

The result has been an inflation rate of roughly 5% for the past 10 years. Compare this to the cost of college in Singapore over approximately the same time frame and you will see an inflation rate of 3.22% (3.) – more in line with what one would expect. Free tuition may also be available in countries such as Germany, which originally abolished tuition fees in 1971 (although it made a comeback from 2006-2014) (4.). Still, a free university education is not always as glamorous as it seems. For example, in Sweden, the government provides tuition to students, but students loans do pile up, with 85% of Swedish students graduating with debt (4.), though that debt does not compare to the growth or amount of debt US students incur.

Take a look at the cost of college and the median US household income.

Part of the American Dream is slipping farther away from parents wanting to see their children do better and from students wanting to experience a respectable standard of living. The math is simple; when the rate of change for college costs increases faster than incomes rise, more borrowing takes place, totaling $1.4 trillion.

New Trends

I hope we start waking up to the current realities and start looking at the picture with a different set of assumptions and planning techniques. The students who recently graduated or who will be graduating soon must start looking at student loans in the same way Boomers have started looking at Social Security to maximize lifetime income. However, instead of looking for ways to increase lifetime income, graduates and parents with student loans must find ways to reduce lifetime expenses.
Students in high school or middle school, and their parents, should closely examine ways to fund college. Start with the basics. (Click here for a timeline associated with the last two years of high school.)

First step

We must look at the larger, more basic formula for college as outlined below.

Cost of Attendance – Expected Family Contribution = Student Financial Need

Most families have this basic formula down. If you have a high school student, how many conversations have you had with him or her about the cost of in-state versus out-of-state tuition and public versus private university costs? Most families try to keep the cost of attendance down without focusing on other aid that may make more expensive universities competitive, in terms of cost, with public in-state institutions.
For example, if private university tuition is $50,000 and a public school costs $25,000, the easy choice (on the surface) is a public university. However, when private schools see that a student has significant financial needs, those schools will likely offer more scholarships, grants, discounts, and money to the student (assuming the college is seeking the student’s attendance).
Only 11% of private school students pay full price for their education (6.). Private universities spend $0.42 of every tuition dollar and revenue on scholarships and grants (6.). Recent years have shown record scholarships and grants issued from private universities.
In the end, the net cost to parents and students matter not the sticker price.

Learning how the formula works for a family’s expected contribution should be the second step.

What is the Expected Family Contribution, or EFC?

In simple terms, this number is the amount of money the government feels your family can reasonably contribute to funding a college education. The formula, while more complicated, is listed below:

(Parent Income + Parent Assets)/# of Children in College + Student Income + Student Assets = EFC

Parent Income – Between 0-47% of total income may be expected minus all taxes and allowances.

Parent Assets – Up to 5.6% of qualifying assets may be counted, such as brokerage accounts, college savings, and savings accounts. Assets such as the family home, retirement plans, and an asset protection allowance do not affect the EFC calculation.

Number of Children in College – If you have more than one child in college, your Student Financial Need changes because assets will cover multiple individuals.

Student Income – 50% of income over the protection allowance counts toward the family’s EFC.

Student Assets – 20% of all assets, including custodial accounts and savings accounts. As with parents’ assets, the EFC calculation ignores family homes and retirement plans. As mentioned before, students also get an income protection allowance.
(Stay tuned for another blog post discussing income protection allowances.)

Now what?

As you can see from the formula, simplicity quickly gets lost and families start ignoring the EFC part of the college funding formula. Here are the next steps for parents and students.

Parents:

1. Starting when your child is in middle school, project your income through high school and college to better understand cash flow and to examine ideal accounts to save college funds.
2. If you own a small business for which your student works, create a plan early for the student’s income to avoid a higher EFC.
3. Create a plan for the gifting of assets to the student while he or she is in college, or a few years before college. Remember that up to 20% of a child’s assets count for the EFC and that only 5.64% may be expected for a parent’s qualified assets. If Grandma and Grandpa gift stock to the kids, you may want to rethink this for a while, or Grandma and Grandpa may want to gift the stock to Mom and Dad instead. (Watch out for the annual gift exclusion amount. Talk to your tax advisor for specifics about your situation.)

Students:

1. If you work, project your income over the next few years before and while you’re in college. You may end up working more your sophomore year versus your junior and senior years. This accomplishes two items: A.) It gives you a longer timeframe for your money to compound, and B.) Because prior-year tax returns are used, a lower income will be reported on the FAFSA.
2. Be careful about receiving gifted assets. See #3 under “parents.”
3. As you plan for college, closely examine whether you will be a better candidate for merit-based or needs-based scholarships and grants.

As always, if you have any questions, use the “contact us” page to let us know what is on your mind or contact us at 317-805-0840.

Sources

1. “U.S. Student Loan Debt Statistics for 2017.” Student Loan Hero. N.p., 11 July 2017. Web. 01 Aug. 2017. https://studentloanhero.com/student-loan-debt-statistics/
2. Clark, Kim. “College Costs Hit Record High in 2016 | Money.” Time. Time, 26 Oct. 2016. Web. 01 Aug. 2017. <http://time.com/money/4543839/college-costs-record-2016/>.
3. “College Access and Affordability: USA vs. the World.” Value Colleges. N.p., 01 Nov. 2016. Web. 01 Aug. 2017. <http://www.valuecolleges.com/collegecosts/>.
4. Mithcell, Michael, and Michael Leachman. “Years of Cuts Threaten to Put College Out of Reach for More Students.” Center on Budget and Policy Priorities. N.p., 29 July 2015. Web. 01 Aug. 2017. <https://www.cbpp.org/research/years-of-cuts-threaten-to-put-college-out-of-reach-for-more-students>.