College Financial Aid (Part 1 of 3)

Whenever I see articles touting financial aid for college it seems like it is almost free money.  Whenever the term financial aid is used, it generally is NOT free money.

There are many strategies to reduce the cost of college education, some of these are covered more at the end of this article.

I like to look at financial aid as different levels of aid:

Level 1: Scholarships – whether it is earned by academics, sports, or is arts-related, this is generally free money and does not need to be paid back

Level 2: Grants – This is generally free money also.  Grants are generally earned on a needs-based method.

Now we get into the financial aid that is NOT free money and needs to be paid back.  This is where students get the majority of their money to pay college expenses. This is also what causes financial difficulties after college, when the student has to start making monthly payments.  Yes, I am talking about loans. I think if people knew the full impact of the actual total cost of the loans, fewer people would use them as they currently do.

Level 3: Need-based loans – The interest rate is generally lower than other type of loans.

Type A: The interest on these loans are generally forgiven (subsidized) as long as the student is attending college.  Payment (principal and interest) will generally start when the student has been out of school for six months. 

Type B: The interest on these loans is added to the principal (non-subsidized but deferred) while the student is attending school.  Payment (principal and interest) will generally start when the student has been out of school for six months.

Level 4: Non Need-Based Loans – The interest rate is generally higher than needs based loans.

Type A: The interest on these loans is added to the principal borrowed while the student is attending school.  Payment (principal and interest) will generally start when the student is out of school for six months.

Type B: This is like most other loans one can get in that payment begins immediately.  There is no forgiveness or deferral of interest or payment.

It is very important to know what type of loan you are signing up for so you can plan when your payments are going to start and how much a month they are likely to be.

You don’t want to be surprised at the end of college with $60,000 of debt and monthly payments of $500 per month (or more) for the next 15 or so years.  This happens at the same time a graduate is trying to get started in life and has monthly apartment payments of $600 and maybe a car payment of $200.  These payments are in after-tax dollars which means you have to make $1,900 per month ($23,000 per year) just to make these 3 payments.  I don’t want to discourage people from going to college, but rather make them aware of all the financial aid rhetoric that seemingly makes it sound like college is affordable by offering a “very competitive financial aid package” to get you through college.

Strategies to reduce the cost of a college education:

Idea 1 – Though this idea is generally not popular with high school graduates, I think it can make a lot of sense for a student who needs to take a lot of loans for college.  Work part time and attend a local college part time and pay cash for the general studies that are required.  Yes, that means they may have to stay at home for several years before going off to school.  But I believe it will also teach the child financial discipline and they will probably be more engaged in their studies.

Idea 2 – If you live in a state that gives a tax deduction or a tax credit for investments in a 529 Plan, invest at least the maximum amount (cash flow permitting of course) to get the tax benefit. In Indiana there is a 20% tax credit for the first $5,000 that you contribute per tax return. So the parents can save $1,000 ($5,000 x 20%) on their joint return and the child (if he owes IN state tax) can also make a contribution to the 529 Plan to reduce their state income tax.  There are additional tax benefits to 529 plans.  Be sure to seek advice from your financial planner or tax advisor before implementing.

Idea 3 – Fill out a FAFSA as early as you can.  There may be scholarships available at the college of your choice that you don’t know about and are only available if a FAFSA has been filed.  Many people don’t fill out the FAFSA because they don’t think they will qualify for need-based aid.  Some scholarships aren’t need-based but do require a FAFSA to be filed.  I have not quite figured out why.

Idea 4 – Look around your community for organizations or corporations that give scholarships.

Idea 5 – Consider going to an in-state college versus a private college. Assuming there are no scholarships available, there could be $10,000 - $30,000 savings per year.

Bill Reno CFP®