How Colleges Determine Financial Need

by Eric Goodhart

Here's a helpful primer on how colleges determine a family's "need" for financial assistance.

How Colleges Determine Financial Need
The two basic methods that colleges use to calculate a family's need for financial aid are the Federal Methodology (FM) and the Institutional Methodology (IM). The FM is primarily used to determine eligibility for Federal Aid (mostly student loans, work-study, Pell, and SEOG grants) and the IM for campus-based aid (mostly gifts). There is only one formula, as determined by Congress every five years (but adjusted annually), that makes up the Federal Methodology. This formula is used by state colleges and some private schools. However, for the more competive private colleges, there are different formulas used to determine your expected family contribution.

The Financial Aid Package
If the college determines you have financial need, they will offer your child a Financial Aid Package. The elements of that package are "self-help" (student loans and non-guaranteed college jobs) and "gift aid" (need-based grants and scholarships).

Often, the composition of the package is determined by where your child places in the applicant pool. Factors such as academic scores, leadership skills, intended major course of study, geographic origin, exceptional achievement and/or skills — all can be rated by the financial aid office as well as the admissions office.

Public School vs. Private School Aid Packages
Private colleges with substantial endowments call this "preferential packaging." The more attractive the student is, the better the aid package will be. It can also be termed "financial aid leveraging." Over 1,000 of the four-year colleges (about 70%) use some form of statistical analysis in their IM calculations to award campus-based funds.

With the exception of a handful of elite colleges, most admission decisions are not blind. It is wise during your investigation of colleges to ask if preferential packaging and/or leveraged analysis are used in both admissions and financial-aid decisions. Colleges are now much more sensitive about your ability to pay than ever before. (Please refer to the article titled "The 7 Questions You Should Ask of Every Financial Aid Officer".)

Other Issues to Be Aware Of
Business or rental property owners are particularly vulnerable in the IM calculations. If your business is a sole proprietorship, partnership, or C or S corporation, your tax returns will undergo special scrutiny. Unfortunately, many colleges assume that if you own a business, you are wealthy, regardless of what is reported on your tax return. The principals of an S Corp suffer doubly, because the Adjusted Gross Income on the personal tax return reflects on line 12 a sum of money that is profit from the corporation on which tax needs to be paid, but which is not necessarily received. Thus, it is not available for personal use (such as college tuition). This is a good example of the relationship of the "nonprofit" ivory tower looking with suspicion upon "for profit" private enterprise.

You may do all the right things from an IRS and business standpoint, but it may not help you when the IM expected family contribution (EFC) is calculated. Your income can be increased by the amount of depreciation reported. Also business, rental, and capital losses will be nullified. Money you are holding in a business account to run your business responsibly (buy inventory, make payroll) will be viewed as a slush fund by colleges, from which you can write tuition checks. All of this can drive your IM EFC to unreasonable heights. To avoid going out of business, you may be forced to extend your debt enormously, or find a college that is fairer — one that will reward your child's achievement and not penalize yours.

How Early Decision Affects Financial Aid
By the way, "if finances are a concern, you shouldn't be applying anyplace early decision," says William Elliott, vice president for enrollment management at Carnegie Mellon University.

This tells the college that not much is needed to get you to enroll, if accepted. And you would be obliged to accept any aid offered. That's good marketing. Several Ivy League colleges are filling a whopping 50% plus of each freshman class from early-decision applicants! Think smart and figure out what your expected family contribution will be before your child applies and see if it will fit into your budget. In other words, buyer beware!