Financial Aid Not Just for Low-Income Families

Note: This article is part of Morningstar's October 2013 College-Savings Boot Camp special report. An earlier version of this article appeared March 28.

A key part of the college-planning equation often is whether admission includes an offer of financial aid and the amount awarded. For upper-income families, financial aid may be an afterthought. They may not even bother applying, assuming they make too much to qualify. But financial aid comes in many forms, and even higher-income families get aid in certain circumstances.

Whether your child is headed to college in the fall or will just be starting preschool, understanding how financial aid works and the role your family income plays can help you better prepare a college financial plan.

Aid Helps Reduce Some--But Not All--of the Burden
First, let's go over some financial-aid basics. About two-thirds of undergraduate students receive some form of financial aid. However, about 38% of this aid comes in the form of federal loans, which must be repaid. (Yes, the federal government considers loans--both subsidized and non-subsidized--to be a form of student aid in that they help students who might otherwise not be able to afford college.) About half of all undergraduate students received grants--which do not need to be repaid and thus amount to free money to attend college--during the 2007-08 academic year, the most recent available from the U.S. Department of Education. Many students receive both federally subsidized loans and grants.

Even with loans and grants widely available, the amount provided is rarely enough to cover all college costs. In fact, during the 2011-12 academic year, college undergraduate students received an average of $13,218 in financial aid per full-time equivalent student (a calculation that incorporates part-time students into the mix), including an average of $6,932 in grants and $5,056 in the form of federal loans, according to the College Board. (Private student loans were not included in the study.) By comparison, average published college costs--including tuition, fees, and room and board--at four-year public colleges averaged $17,136 (in-state) and $29,703 (out-of-state) that year, while the same costs at not-for-profit private colleges averaged $37,971.

Since federal student loans are readily available--in particular unsubsidized Stafford and Parent Plus loans--and since most families are more interested in financial aid that does not have to be repaid, we'll focus our attention on grants and scholarships and how much income is too much to qualify for these benefits.

Grant Availability Varies by Source
Bear in mind that grants and scholarships can be need-based or merit-based, and come from four primary sources: the federal government, state governments, private sources, and the colleges themselves. Because each source uses its own criteria for providing aid, it's difficult to say with certainty that students from mid- to upper-income families will or won't qualify in all cases. However, a closer look at the numbers can lead us to some conclusions:

Federal grants targeted at lower-income families: The table below shows the percentage of undergrads receiving federal grants and the percentage receiving federal loans by family income for the 2007-08 academic year (the most recent data available):

As you can see, federal grants tend to be aimed at low- to moderate-income families (Pell Grant recipients come from households whose median income is just $16,300, for example). For families making less than $40,000 per year, odds of receiving federal grant money are good, but for those making more than $60,000, such awards tend to be rare. Federal loans, on the other hand, are more widely available even at higher income levels, with nearly one-third of students from households making $100,000 or more using them.

Nonfederal grants more available to higher-income families: Now let's look at the same federal grant figures used above, but this time comparing them with nonfederal grant awards by income level. (Nonfederal grant sources include state governments, private entities, and colleges themselves.)

As you can see, at incomes of $40,000 and above the likelihood of receiving a nonfederal grant is much greater than it is for a federal grant.

More than half of all grant money comes from nonfederal sources, according to the College Board. In 2011-12, 44% of all grant aid for undergraduate and graduate students came from the federal government, with colleges the second-largest source at 37%, 10% from private sources, and 9% from state governments. In recent years, states have been allocating more student aid on the basis of merit, although most still award the majority of their grant aid based at least partially on economic need. On average, states allocated 71% of grants on the basis of need during the 2010-11 academic year.

Why the FAFSA Matters
Because of the availability of nonfederal grants even to students from higher-income households, college planning experts often recommend that such households also fill out the Free Application for Federal Student Aid (FAFSA), the financial aid application form used by all public and many private colleges across the country. (Some private colleges use the CSS/Financial Aid PROFILE form instead.) Various sources (federal and state governments, institutions, etc.) use the FAFSA not just to determine eligibility for need-based grants, but for loans and merit-based grants as well.

"We say that everyone should apply because even if you have a high income, while you might not qualify for federal or state money, you still may get money from the institution," says Scott Weingold, co-founder of College Planning Network, a fee-based college admissions advisory service near Cleveland.

Weingold says that when it comes to qualifying for need-based grants "there are a lot of misconceptions. A lot of people who make $100,000 think there's just no way, but that's just not true."

Financial Aid's Secret Sauce
Key to understanding the impact of income on financial aid eligibility is learning how financial aid formulas work. They're rather complex and vary from school to school, but they basically use answers to questions about family income, assets, and size to help arrive at a special number known as the expected family contribution, or EFC. The EFC represents the amount of tuition, fees, and other college costs the family is expected to cover based on its financial situation and other factors.

Mark Kantrowitz, publisher of the college finance website Finaid.org and a nationally recognized expert on financial aid, summarizes the process this way: "Financial aid is based on financial need. Financial need is defined as the difference between the cost of attendance (at a university) minus the expected family contribution."

Not all assets are counted when calculating the EFC. For example, assets held in retirement accounts don't count, and home equity is not counted on the FAFSA, although aid formulas used by private colleges may ask for it.

Income More Important Than Assets
However, income plays a far greater role than assets in determining EFC. As much as 47% of income may be used in calculating a family's EFC, whereas parental assets are assessed at a maximum of 5.64%, and student-owned assets at a maximum of 20%. (The formula assumes that a greater percentage of student-owned assets are available to help pay for college because parents usually have other household expenses to worry about.) Kantrowitz estimates that for every $10,000 in additional income, the EFC for a family with one child in college increases by $3,000, whereas for every additional $10,000 in parent-owned assets it increases by only $564.

Financial-aid awards are based on the previous calendar year's income, so some families use strategies to reduce income the year before applying. For example, if one parent is considering retiring or going back to school, doing so will likely reduce the family's income, thus increasing aid eligibility. (Having more than one student in school also has additional financial aid benefits, as we'll see in a moment.) A parent also may ask that a work bonus be postponed to reduce income that counts against aid.

One common mistake families make is selling securities the year before the student enrolls as a way to cover college costs. But any capital gains from the sale count as income in the following year's financial aid calculation, so it's best to sell securities the year before the base year (in other words two years before the student enrolls), when the proceeds won't be counted as income (although they will still count as assets later on).

Having Multiple Students Helps--a Lot
Among the most important factors involved in financial aid calculations--and one that can have the most dramatic impact on need-based aid eligibility for high-earning families--is the number of students attending college at the same time. Having two students enrolled at once essentially cuts in half the amount of the expected family contribution for each student, says Weingold. "If you make $100,000, your expected family contribution is about $25,000," he says. "If you have two students in school at the same time that gets split in two, so the expected contribution is $12,500 for each." This lower EFC increases the likelihood of each student receiving need-based aid.

Choice of School Also Matters
Another important factor is the amount of financial aid available from the school itself, which can vary greatly but which is often higher at private institutions. Many families who qualify for little or no need-based aid at public colleges don't realize that they may get a better aid offer--and indeed comparable or even lower tuition payments--at a more expensive private school. "I have told students before that you shouldn't necessarily assume that applying to a private college will be more expense out of your pocket," says Karen McCarthy, a policy analyst for the National Association of Student Financial Aid Administrators.

Kantrowitz says that students from higher-income families tend to receive better aid offers from pricier colleges. "At these $50,000-, $60,000-a-year schools, you have middle- and upper-income family students qualifying for need-based grants," he says.

To illustrate, Kantrowitz says that at a college charging $60,000 a year, a student whose family makes as much as $150,000 a year with no other children in college may qualify for a need-based grant. For a family with two students in school at the same time, the top end of grant eligibility jumps to $330,000 in income.

Merit-Based Aid and High-Income Families
Thus far we've talked exclusively about need-based grants and scholarships, but merit-based grants and scholarships are another important financial aid source for upper-income families. Kantrowitz says colleges shape their merit-based aid programs according to the type of students they hope to attract. This may include providing incentives to attend the school for students from certain demographic backgrounds, students with high entrance exam scores, and students with other desirable characteristics, including high family incomes, he says.

Using 2007-08 data from the National Postsecondary Student Aid Study conducted by the U.S. Department of Education, Kantrowitz found that the odds of receiving merit-based aid actually increased with family income. Below is a chart that shows the percentage of students nationwide receiving purely merit-based institutional grants grouped by the family's adjusted gross income (AGI):

Kantrowitz says some colleges use merit-based aid to entice wealthier students whose families can afford to pay full tuition but who might be swayed to pick the school that seems to want their student the most. It also doesn't hurt that students who receive merit-based aid usually end up paying more in tuition than those receiving need-based aid, he adds.

"It's mind-boggling that the wealthier you are, the more meritorious you are," Kantrowitz says.

Calculating the Cost
While a student's odds of receiving financial aid can vary greatly from school to school, colleges that participate in the federal financial aid program are required to post net-cost calculators on their websites that allow students to estimate the amount of aid they may receive if they attend that school. The results are nonbinding, and admission is not guaranteed, but these calculators can provide a useful ballpark estimate as to what the out-of-pocket cost of attendance might be given a student's specific circumstances. Plus, using them is a good way to learn about the sorts of questions you will be asked as part of the financial aid application process.

Perhaps because of the complexity of the process, it's easy for families to make assumptions about their financial aid prospects. After all, assuming you make too much to qualify, or that your child is too talented not to be offered a scholarship, is the easy way out. The least you can do, regardless of your family's financial picture, is to fill out the FAFSA. It's a relatively straightforward application that could result in thousands of dollars in savings to your student's college bill.