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Trends in College Financial Aid

Karen Wallace, CFP®

Karen Wallace: For Morningstar, I'm Karen Wallace. College-application deadlines are fast approaching, and there have been recently announced changes with the Free Application for Federal Student Aid, or FAFSA, as it's known. Here today to discuss the impact of some of those changes as well as some advice for filling out the FAFSA is Mark Kantrowitz. He is publisher of Edvisors.com, a college-planning website.

Mark, thanks for joining me today.

Mark Kantrowitz: Thank you for having me.

Wallace: Let's get to some of the changes recently announced with FAFSA. In September, President Obama announced that we would move from using prior-year income and tax data to prior-prior-year income and tax data for 2017-18 FAFSA. How would this simplify the application process?

Kantrowitz: So, for the current FAFSA, we have this song and dance about how you can't file it before Jan. 1, but you must file it as soon as possible after Jan. 1, and you shouldn't wait until you file your federal income tax returns to file the form. And that's because the current FAFSA, which is for financial aid for an upcoming academic year--for example, students might be filing the FAFSA now for the 2015-16 academic year--is based on the prior-tax-year data, which is verifiable. So, if you're filing the 2015-16 FAFSA, you would be basing it on the 2014 taxes. The change starts with the year 2017-18, which normally would have been based on 2016 tax-year data--one-year-old data--and instead it's going to be switched to 2015 tax-year data--or two-year-old data. So, in 2015, we're actually going to have two separate FAFSAs based on that year: We will be filing the 2016-17 FAFSA starting Jan. 1, and we'll be filing the 2017-18 FAFSA starting Oct. 1.

Wallace: Another recent change is that the Department of Education will no longer share the list of colleges on the student's FAFSA with the colleges. Can you discuss the impact of this change?

Kantrowitz: When students were listing their colleges on the FAFSA, they were usually listing them in a kind of preference order where their top-choice school was listed first, their second-choice school was listed second, and so on. And the schools had data that showed that if you were listed first and you got into that school, about 60% of the students would actually enroll at that school, whereas if you were listing the school fourth, less than 10% of the students admitted to that school would actually enroll. So, some colleges were using this to influence their college-admissions and financial-aid decisions. Nobody admitted to it openly, but it was an open secret among the colleges that some were doing this.

That's actually a violation of the Higher Education Act. The FAFSA data can only be used for applying for financial aid; it cannot be used for any other purpose. But because of the apparent abuses, the U.S. Department of Education decided that it would no longer provide this information to the colleges so that they could no longer know, at least from the FAFSA, whether or not that student listed them first--whether they were a first-choice school or not.

Now, there are other forms, such as from the ACT and perhaps the SAT that may share this kind of information with the colleges; however, at the NACAC Conference--National Association of College Admission Counselling--the members voted to amend their ethical standards to ban use of this kind of information. So, any college that is a signatory to that, which is most colleges, cannot use information from financial-aid application forms or other types of application forms concerning whether the students are listing them first, second, third, and so on.

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Wallace: Mark, you've written that one of the biggest mistakes that people make when filling out the FAFSA is failing to fill it out at all. Why is this one of the most common mistakes?

Kantrowitz: Well, it's the most harmful mistake. If you don't apply for aid, you can't get any. Each year, about two million students who would have qualified for a Federal Pell Grant didn't received it because they didn't file the FAFSA and, of them, 1.3 million would have received a maximum Pell Grant--this year, it's $5,775. They are leaving money on the table, and that's quite harmful. These students, because they didn't apply for financial aid, are going to try to work their way through college, and someone who is working a full-time job is half as likely to graduate as someone who works 12 hours or less a week.

Wallace: What are some other common mistakes people make when filling out the FAFSA?

Kantrowitz: Well, another mistake is having a typo in their date of birth or Social Security number. Your name and date of birth must exactly match the Social Security Number on record with the Social Security Administration. So, if you go by a nickname, you still have to use your legal name when filing the FAFSA. It's not uncommon to have an extra zero added to income figures or transpositions where you switch two adjacent digits, and that could have a big impact on your aid eligibility if it affects a dollar amount such as income.

Having errors in which parent's information you provide, if your parents are divorced and don't live together, [can be a problem]. It's the parent with whom you live the most. If that's equal, then it's the parent who provides the most support. Now, if that parent has remarried, the step-parent's information must be included. But oftentimes, the step-parents forget about children that they have from a prior marriage. If that step-parent is providing more than half of that child's support, then that child should be counted on the student's FAFSA. And if they are in college, [that child should be included in the number of children in college], even if that child doesn't live with the step-parent. That can have a very big impact on the amount of financial aid because the number of children in college acts as a divisor to the parent contribution. So, when you go from one child in college to two children in college, it's like dividing the parent income in half.

Another major problem is sometimes people will count their retirement plans and the net worth of the family home as part of their assets. On the FAFSA, both of those are ignored. If it's in a qualified retirement plan account, such as a 401(k), 403(b), 457, IRA, Roth IRA, SEP, SIMPLE, or Keogh plan, it's ignored on the FAFSA. Distributions from those plans and current contributions to those plans count as income, but as an asset they are ignored.

Wallace: Finally, let's turn the discussion to a topic that's not directly related to the FAFSA but is nonetheless on people's minds, and that's rising interest rates and what impact those would have--if any--on student loans, federal or private?

Kantrowitz: Federal student loans have fixed interest rates. So, your current loans will not change even if the Federal Reserve increases the interest rates. However, next year's loans--and the rate resets each July 1--may increase if the Federal Reserve increases the federal-funds rate.

Now, the Federal Reserve Board increases interest rates typically by 0.25% each time it raises interest rates, and that itself will not have that big of an impact. That increases the monthly payment on $10,000 with a 10-year repayment term by about $1.25 a month. It's not a very big impact. However, when the Federal Reserve starts increasing interest rates, it's usually going to transition to a series of increases. For example, the last time they raised interest rates, they did a series of 17 quarter-point increases over a two-year period from June 2004 to June 2006. That is a cumulative increase of 4.25%. That kind of an increase on the typical debt at graduation--say $35,000--will increase the monthly payment by about $75 a month. So, that's a much more significant increase.

Given that it's very likely that the Federal Reserve will increase interest rates by the end of the year, if you have a variable-rate student loan, such as an older federal student loan from before 2006 that hadn't been consolidated or a private student loan that has a variable interest rate, you might want to refinance that into a fixed rate before the interest rates start increasing too much.

Wallace: Mark, thanks for joining us today to share your advice and insights.

Kantrowitz: You're welcome.

Wallace: For Morningstar, I'm Karen Wallace.