How College Financial Aid Works

There are a variety of financial aid tools available to students today, including scholarships, need-based awards, work-study employment and student loans. Let's start with need-based financial aid.

Nearly two-thirds of today's full-time college students receive some form of need-based aid [source: NCES]. Need-based financial aid eligibility is based on two calculations -- the total cost of education and the family's ability to pay. The cost of education can vary significantly from institution to institution. Generally, these calculations include all reasonable costs (tuition, room, board and living expenses) of attendance.

To apply for need-based financial aid, families must complete the Free Application for Financial Aid (FAFSA) and, if appropriate, the College Scholarship Service's PROFILE application. These documents are used to determine what amount, if any, a family (and that means both parent and student) can contribute to the annual cost of attendance. That number is known as the Expected Family Contribution (EFC). The specific amount of your EFC may vary somewhat from institution to institution, but the formulas in place ensure that most EFCs are similar.

The formulas consider a variety of family circumstances when determining eligibility. (The College Board Web site has some great financial aid calculators you can use.) Consequently, there's no real cut-off point or maximum income a family can have and still qualify for assistance. Even if you have a comparatively high income, you may still qualify for need-based aid, particularly if you have more than one child in college. Every student, regardless of financial situation, should consider applying for need-based aid to see what happens.

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If there are any extenuating circumstances affecting your ability to pay for college, your school's financial aid office should be able to help.

There are two need-based aid applications being used nationally, the Free Application for Federal Student Aid (FAFSA) and the College Scholarship Service's PROFILE. The FAFSA is the application for all federal funds and is required by all institutions of higher learning. Many institutions will require complete copies of your most recent tax and W-2 forms.

The PROFILE, which is generally viewed as the application for private or institutional funds, is required by many -- but not all -- institutions. If you're applying to a college whose aid awards include significant levels of institutional funding, there is a good chance that the school will require both forms. If you're unsure which form(s) is required, check with your school's financial aid office.

The FAFSA and the PROFILE rely heavily on numbers from your income tax returns. If you're applying as a dependent of your parents, then the numbers will come from your parents' tax returns. If you are applying as an independent, then use your own tax returns.

In addition to income and asset information, each form also collects demographic data including family size, parent age, number of students in college and other related information. You're also invited to provide each school with information on any extenuating circumstances that affect your family's ability to support educational expenses. Take advantage of the opportunity to provide this information by writing directly to the college(s) you're considering. Don't be shy -- others won't be.

Both the Department of Education and the College Scholarship Service apply "need analysis" formulas to the information your financial aid applications supply. The government's formula is called the Federal Methodology and the CSS/PROFILE formula is called the Institutional Methodology. Both formulas --which were designed by Congress and by the educational community respectively -- differ in important ways, but each estimates how much your family can provide toward educational expenses in the upcoming year.

In general, the Institutional Methodology considers more sources of income and assets than the Federal Methodology. Examples include home equity, non-custodial parent income and expected student earnings from summer jobs. For this reason, the Estimated Family Contribution calculated by the Institutional Methodology is often higher than the EFC calculated using the Federal Methodology.

Both the FAFSA and the PROFILE are available through guidance counselors' offices and both can be completed online. Either way, each form takes about an hour to 90 minutes to complete. You must complete and submit each form once every year. With each form, list all of the colleges to which you intend to apply. The Department of Education and the College Scholarship Service will take care of the rest by sending copies of your form to the institutions you have listed. Even after you are enrolled in college, you must complete and submit a new form for every year you want to receive financial aid.

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The campus of Duke University in Durham, N.C.

As we explained, the Expected Family Contribution calculations and financial aid packaging policies vary from institution to institution. Here's an example of what might happen at Duke University in Durham, N.C.

A family completes and submits the PROFILE and FAFSA no later than March 1. (The school requires tax forms, but those aren't due until March 15.) Duke also invites the family to submit letters that explain any extenuating circumstances that might affect their ability to support educational expenses.

At Duke, students are admitted without reference to their need for financial aid. This policy of "need-blind admissions" means that the school doesn't determine an applicant's aid eligibility until after the student has been admitted. As soon as the financial aid department learns of a student's admission, it pulls together the application materials, determines aid eligibility and prepares awards for those who are eligible. Who will be eligible? The formula Duke uses considers a wide variety of circumstances -- there is no right answer. However, here's an example of a fairly typical applicant's award:

The Smiths are a family of four. Both parents work, and Melissa, the Duke applicant, will be the only one in college next year. Their family income is roughly $60,000 and their assets are pretty standard relative to their income. They own their own home and have offered no unusual circumstances.

In this case, the parents' contribution would likely range from $8,000 to $12,000. Melissa's contribution in this example is $2,000, with $1,900 coming from summer earnings and $100 coming from Melissa's savings. The cost of attending Duke for the 2009-2010 school year is $53,000. For illustration purposes, let's assume that the parents contribute $12,000. So here are the numbers (all figures are in U.S. dollars):

In addition to guaranteeing need-blind admissions, Duke meets 100 percent of each student's demonstrated need. Here is how this works:

The number of siblings in school at the same time is important. Parent contributions generally go down by 40 to 50 percent if more than one child is in school. Remember, this is just one example, and your results are likely to be different. For specific details, contact your prospective institution's financial aid office.

If you demonstrate need, you're eligible for need-based financial aid. Demonstrated need is a simple concept -- it's each institution's cost of education minus the Expected Family Contribution (EFC). So the "formula" looks something like this:

Cost - EFC = Aid Eligibility

If your aid award includes federal dollars -- and most do -- your total aid cannot exceed your demonstrated need. Some institutions will meet 100 percent of your demonstrated need; others will meet only a portion of that need. Regardless of the portion of need that a school meets, almost all package aid offers three types of assistance:

• Loans -- Low-interest student or parent loans that will need to be repaid
• Grants -- Federal or institutional awards that don't have to be repaid
• Work-study --Part-time campus employment subsidized by the Federal government.

The breakdown of funding in each financial aid package varies from one college to another. While grants are everyone's favorite type of financial aid, don't discount work and loan opportunities.

Federal law requires that you reapply for need-based financial aid each year. There are no exceptions. Applications are generally available in early December of each year. Mark your calendar to reapply in December. You don't want to receive your fall bill and discover that you failed to apply for aid. At that point, it may be too late!

In most cases, a school will tell you of your financial aid eligibility at the time that admission is offered. Colleges and universities know that you are concerned about costs and most will not ask you to commit to them until they commit to you.

If you don't qualify for aid in the first year, apply again in the second year. Circumstances change and so does aid eligibility. You may be surprised to find that you receive aid in the second year. And if your circumstances change mid-way through an academic year, most institutions are willing to meet some or all of your newly demonstrated need.

Now let's look at each type of need-based financial aid award, starting with loans.

This is where we get to the "paying for college after graduation" part -- and that means borrowing money. Borrowing should always be used as a last resort to pay for college. That said, borrowing can and should be used to close the gap between the resources available to your family and the cost of the institution your student wants and deserves to attend.

For many families, home equity represents their largest "savings" account. If your home has equity value, you should consider using it to pay for college. Although not always true, home equity loan interest rates are often lower than those charged by commercial loan sources. Additionally, home equity loan interest is tax deductible, which further lowers the cost of attendance. Equally as important as low interest is the fact that home-equity payments can be extended over a longer period than just the four years of enrollment.

There are, of course, student loans and parent loans -- both of which are becoming more important all the time as families struggle to pay the rising costs of higher education. For more on each, read on.

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Federal student loans are the easiest way to college students to borrow the funds they need for school.

Federal loans are the most accessible and affordable loan resources for students. There are two federal programs available nationally: the Stafford and Perkins programs. Both provide low-interest, payment-deferred loans that borrowers can repay after their enrollment ends.

Interest -- capped at 6.8 percent for Stafford loans and 5 percent for Perkins loans through 2013 -- is subsidized by the government to keep rates low and only begins to accrue after the borrower begins repaying the loan. To qualify for interest-subsidized Stafford or Perkins student loans, the student must demonstrate need by completing the FAFSA. Although several different repayment plans are available, most students repay these funds over a 10-year period.

Undergraduates may borrow as much as $5,500 in Perkins funds each year with a total amount not exceeding $27,500 [source: Federal Student Aid]. Stafford borrowers may borrow $5,500 in the first year, $6,500 in the second year and $7,500 in the third and fourth years [source: Federal Student Aid]. Independent undergraduate students qualify for even higher loan amounts. Additional Stafford and Perkins loans, with higher annual borrowing limits, are available to graduate and professional students.

Perkins loans include both federal and institutional funds and reside on campus. If you're offered a Perkins loan, you need only to sign the promissory note.

Stafford loans are slightly more complicated. You must choose the lender who will carry your loan, usually a bank or credit union. If your school participates in the Direct Loan program (more than 2,200 schools now do), funds will come directly from the Federal government [source: Caplinger].

Students who are unable to demonstrate need through the FAFSA may still borrow from the Stafford student loan program. These funds are unsubsidized, meaning they carry higher interest rates and must be repaid starting at the time of receipt.

In addition to federal loans, student should research private loans, which can sometimes offer competitive terms. As with local scholarships, check with fraternal organizations and churches or synagogues. Finally, an increasing number of colleges and universities are offering institutional loans at very reasonable rates.

Regardless of whom you borrow from, take this message to heart: Pay on time and you can save money. If you have problems, don't default. Contact your lender, who can offer you a variety of repayment options.

Student loans don't have to be a burden on the student alone. For more on parental student loans, read on.

A growing number of parent loans are available nationally. The federally supported Parent Loan to Undergraduate Students (PLUS) offers low interest (not interest-subsidized) loans for which repayment begins 60 days after funds are disbursed. Parents can apply for PLUS loans by completing either a PLUS Loan application or a Direct PLUS Loan application (if your school participates in the federal Direct Loan program).

PLUS loans are designed to fill in the gap between student financial aid awards and the total cost of attendance. For that reason, the amount of a PLUS loan cannot exceed the price difference between cost of attendance and the amount of financial aid already received [source: Federal Student Aid]. For example, if your college costs $40,000 a year and you already receive $30,000 in aid, the PLUS loan cannot exceed $10,000.

There are also many private parental loans offered under a variety of terms and interest rates, some allowing repayment over as long as 20 years.

Almost all parent loans require some type of credit check. The PLUS loan credit check is the most liberal, requiring only that parents have had no credit problems within 60 days of application. The credit check for private parent loans is more stringent and generally requires that the applicant's debt-to-income ratio meet a specified standard.

The good news about most parent loans is that the applicant can borrow up to their student's cost of education minus any available financial aid. Parent loans should be viewed as cash flow loans or as a way to close the gap between the cost of the school of choice and those other resources your family has identified.

Now that you know all about loans, let's learn all about grants on the next page.

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Think of it as free money: Grants never have to be repaid.

A grant is considered the best form of financial aid because it's money that never has to be repaid -- ever! Grants are based on demonstrated financial need and are awarded by both federal and state governments, as well as individual colleges.

The Pell Grant is the most common type of federal grant. Eligibility for a Pell Grant is determined by completing the FAFSA. The maximum Pell Grant award amount for the 2009-2010 academic year is $5,350 per student [source: Federal Student Aid] .

In addition to the Pell Grant, Congress recently allocated extra grant money for applicants demonstrating great financial need. This money -- up to an additional $4,000 a year -- is available through the Federal Supplemental Educational Opportunity Grant (FSEOG) [source: Federal Student Aid].

If you are enrolled in an undergraduate teaching program, you may also be eligible for a federal TEACH (Teacher Education Assistance for College and Higher Education) grant. Students who sign a pledge to teach in a low-income school for at least four years can receive up to $4,000 per year in additional funds [source: Federal Student Aid].

Each state has its own grant money to offer qualifying students. States determine their grant awards based on the FAFSA, so there is no need to submit a separate application. Each state has its own FAFSA application deadline, however, so check with your state Department of Education for more information.

Individual schools also offer grants as part of their financial aid packages. A few schools -- mostly competitive private colleges -- have replaced loans entirely with grants for families who earn below a certain income threshold. At Yale and Harvard, students pay nothing if their families earn less than $60,000 a year. Pomona College in California offers full-ride grants to families that earn under $45,000 [source: Lorin].

Princeton University is the only college in the United States with a "no loans" policy for all students. That means that Princeton vows to meet the demonstrated need of all families exclusively with grants and campus jobs, even for international students [source: Princeton].

If you want to earn some money for school while you're in school, a job funded by the Federal Work-Study Program is another financial aid option. Depending on the level of need demonstrated in your FAFSA, a Work-Study job can be an excellent way to earn thousands of dollars a year toward tuition.

With a Federal Work-Study job, you're paid directly by your school, but the government reimburses the school for your paycheck. Federal Work-Study jobs must pay minimum wage, but often pay more. They can be hourly or salaried positions, but must deliver a paycheck at least once a month. Total earnings cannot exceed the total amount of the student's Federal Work-Study award [source: Federal Student Aid].

The Federal Work-Study program encourages students to find employment that's related to their field of study. Schools reserve a certain amount of on-campus jobs for work-study students, everything from library assistants to admissions office representatives, dining hall workers and landscape teams.

Schools also maintain a list of off-campus positions that qualify for work-study funds. These are primarily with nonprofits, government agencies and other institutions dedicated to the "public good" [source: Federal Student Aid].

One of the benefits of a work-study job is that your employer (the school or off-campus organization) knows that your education is your top priority and will work around your class schedule. The average work-study schedule is between 10 and 15 hours a week [source: eCampusTours].

Of course, options abound if you want to earn money for school before you graduate from high school. Let's discuss scholarships on the next page.

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Merit scholarships are awarded to the best and brightest students.

Merit-based scholarships are one of the few types of financial aid that aren't based on demonstrated financial need. Merit scholarships are awarded to students based on strong academic abilities, leadership skills, artistic or musical ability, and athletic abilities, including specialized activities like cheerleading.

Compared with need-based financial aid, merit-based scholarships are few and far between. Many schools offer no merit-based aid at all. Still, students should apply for any scholarship that seems like a good fit. There are four important things you should know about merit scholarships:

• You need to know which schools offer merit scholarships -- not all do. You can find this out by contacting the financial aid office of the schools in which you're interested.
• You need to know how and when to apply for each scholarship. Deadlines are critical. Don't miss out on scholarships because your application was late. The school's financial aid Web site will provide you with all the information you need to apply on a timely basis.
• Parents and students need to keep merit scholarships in perspective. Regardless of what you might hear, merit scholarships aren't, by themselves, reason to attend a particular school. A merit scholarship may serve to underline the reasons for choosing a particular school, but remember, academic and social interests and goals should drive this decision.

A great place to start your scholarship search is through local organizations and institutions. Read more about finding these scholarships on the next page.

There are two kinds of local scholarships: the "Who-are-you-what's-your- heritage-where-are-you-from-who-do-you-know?" scholarships, and the competitive merit awards. For the first type of local scholarship, students are selected on the base of religion, ethnicity, professional affiliations or employment.

The second group features scholarships for which students can compete locally. These include PTA scholarships and civic awards (such as those provided by the Kiwanis Club, the Exchange Club and the Jaycees). The first group of scholarships generally requires only an application, while merit scholarships usually require a paper, speech, project or other form of competition.

Someone in your community is going to receive these scholarships. There are four places where you can find out about these awards:

• Your kitchen table -- Sit down as a family and consider your various family connections. Consider your religious affiliation. Parents, perhaps you are a member of a club or fraternal organization that offers scholarships for which your child may apply. Many corporations provide scholarships to the children of employees. Perhaps your company does. If you have an affiliation that could lead to a scholarship, follow up on it!
• The high school guidance counselor's office -- Students should stop by regularly and read the counselor's bulletin board. You may be surprised by what you find.
• The local library -- The library bulletin board and resource section can provide you with very real scholarship opportunities.
• The Internet -- The Internet is a rich source of scholarship opportunities -- both local and national. Search for scholarships at sites like The College Board, SallieMae.com, USAGroup and Fastweb.com. These sites offer excellent advice on paying for college and often list national scholarships for which you may apply. As a rule, you should avoid working with any scholarship or financial aid search firm that charges a fee for its services. Almost without exception, any scholarship funds available for a fee are also available for free.

Many national organizations, corporations included, also offer valuable scholarships.

Campus jobs aren't exclusively for students receiving Federal Work-Study aid. Work-study students are given top priority, but other students can apply for campus jobs, particularly those related to their academic work (research or lab assistants, for example).

Working while in college offers the student more than just the chance to make money. College jobs allow students to work with faculty and administrators who can often serve as mentors. Just as importantly, campus jobs often provide students with the opportunity to examine various career options. At the very least, potential employers appreciate the fact that students worked while they were in college.

Although working while in college is important, it's not for everyone. Working, like the rest of one's college experiences, must be kept in perspective. Working should be a complement rather than a hindrance to your studies. Here are a few employment options to consider.

Summer employment --Although resting up from the rigors of the academic year or lounging around at the beach are much more fun than working, summer jobs can make a college education much easier to finance. The average student can make from $1,500 to as much as $6,000 by working during the summer. And internships and other forms of summer employment provide a student with another chance to look at a variety of careers. If the student receives a need-based aid award, a summer savings expectation will be included in your family contribution.

Internships and cooperative education programs-- Internships and cooperative education programs provide students with wonderful opportunities to earn while they learn. Internships are generally available during the summer. Co-op programs, generally available during the academic year, often extend the period of enrollment beyond the normal four-year plan. This is something to consider since these programs often allow the student to work with potential employers while they are in school. This can be an invaluable experience and can sometimes lead to full-time employment after graduation. Check with your prospective college's career service office for details on both internships and co-op programs.

Want some more options? You'll find a relatively unique one on the next page.

Many parents who were in school in the 1960s will remember that Reserve Officer Training Corps (ROTC) programs fell out of favor with a lot of people. Well, times have changed. Today, ROTC programs are more popular than ever. Army ROTC enrollment for the 2008-2009 school year totaled 30,721 cadets, an eight percent increase over the previous year [source: Badders]. ROTC programs aren't for everyone, but they might be right for you.

Offered by the Army, Air Force and Navy (not at every school, so check the brochure), ROTC programs provide participants with scholarship funds for tuition (sometimes full, sometimes partial), books, fees and a monthly stipend of $300 a month for first-year students up to $500 a month for fourth-year participants [source: GoArmy]. Students are expected to take a few military science classes, participate in drills and attend summer camp programs. Following graduation, ROTC students are required to spend some period of time on active or reserve duty.

As you consider ROTC programs, don't forget about the free clothing -- hats and shoes, nice travel bags (all in military colors, of course) -- summer vacations, and the fact that you don't have to look for a job following graduation. The possibility of subsidized graduate work can be an additional benefit.

• 
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  Paying for college isn't all that difficult -- as long you plan wisely.
  Start saving for college now. This is good advice for parents and students because the more you save, the less you have to borrow.
• It's not the college's sticker price that matters. All that really matters is the net cost of education. In most cases, there is a difference between the family's out-of-pocket expense and the college's sticker price.
• Use time to its fullest advantage. For most families, college is the second largest expense they will ever incur. Most families pay for their homes over as many as 30 years -- consider paying for college over six to eight years, or longer.
• As your student creates the list of schools to which he or she will apply, don't eliminate a school just because it's expensive. A great deal of assistance is available, and you may be surprised at how much you or your student receives.
• Parents, get your child involved early in paying for college. By saving during high school and by working during college, students can make an important contribution toward supporting their educational costs.
• As a family, create a strategy that fits your particular set of circumstances. Remember -- there is no best way to pay for college.
• Keep educational costs in perspective. College costs may be going up, but recent studies indicate that those who earn a bachelor's degree on average will have lifetime earnings approximately 60 percent higher than those who stop at a high school diploma. The return on your investment can be extraordinary.

Here are a few final thoughts:

• If you create a family strategy through which you can start planning early, if you take advantage of the wide variety of programs available during college, and if you are willing to borrow when necessary and reasonable, then the college you deserve can be available.
• Why not view the financial aid officer at your college as a resource? These professionals will be pleased to help you think through the maze of payment options available for your consideration. They are also good at helping students budget their expenses while in college. Maybe, just maybe, the aid officer can help you find a grant to replace the loan for which you might otherwise have to apply.

Parents, keep this in mind: If you don't do all you can to ensure that your child is well-educated, he or she may come back home and live with you. That, if nothing else, should scare you into action!

For more information on paying for college, take a look at the links on the next page.