Financial Aid 101

When saving for college, a good rule of thumb is to save at least 50% of the expected cost. That’s because the remaining cost will most likely come from financial aid. This is money distributed primarily by the federal government and colleges in the form of loans, grants, scholarships and work-study jobs. The majority of financial aid is need based or dependent on your child’s financial need. There is also merit-based aid awarded based on your child’s academic abilities.

How do I apply for financial aid?

To apply for financial aid, you’ll complete a form called FAFSA. Generally, a parent and child’s income and assets are tallied and assessed at certain rates to come up with your expected family contribution or EFC. This is the amount of money you must contribute to college costs to be eligible for aid. Your EFC remains constant, no matter which college your child applies to.

What counts the most?

Your current income is the most important factor in determining need, but other factors play a role, such as your total assets, how many family members are in college at the same time, and how close you are to retirement age.

Your EFC is not the same as your child’s financial need. To calculate financial need, subtract your EFC from the cost at a given college. Because tuition, fees, and room-and-board expenses are different at each college, your child’s financial need will vary depending on the cost of a particular college.

Example:   You fill out the FAFSA and your EFC is calculated at $5,000. College A costs $20,000 per year and College B costs $40,000 per year. Your child’s financial need at College A is $15,000 and $35,000 at College B.

How do colleges calculate financial aid?

Colleges have their own way of determining financial aid. Basically, the process works the same way as with the federal government, except that the institutional methodology embodied in the standard college PROFILE application typically takes a more in-depth look at your income and assets to determine how “needy” your child really is. For example, colleges often consider your home equity and retirement accounts in assessing your ability to pay college costs.

Tip: Just because your child has financial need doesn’t necessarily mean that colleges will meet 100% of that need. In fact, it’s not uncommon for colleges to meet only a portion of that need, a phenomenon known as getting “gapped.” If this happens to you, you’ll have to make up the shortfall, in addition to paying your EFC. College guidebooks compare how well colleges meet their students’ financial need under the entry “average percentage of need met” or something similar.

How much should you 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 the college bills. But the reality is you shouldn’t rely too heavily on financial aid. Although aid can certainly help cover your child’s college costs, student loans often make up the largest percentage of the typical aid package, not grants and scholarships.

As a general rule of thumb, plan on student loans covering up to 50% of college expenses, grants and scholarships covering up to 15%, and work-study jobs covering a variable amount. But remember, parents and students who rely mainly on loans to finance college can end up with a considerable debt burden.

Note: Azzad Asset Management does not provide tax or legal advice.