We can't afford the tuition -- and we're not poor enough to qualify for financial aid.
I'll have to refinance my house.
There goes my retirement money.
These are just a few of the depressing assumptions that come to mind when parents consider how to pay for college. And with good reason, as tuition continues to rise faster than the rate of inflation. This past school year, average total tuition and fees at private colleges rose to $22,218 -- 5.9 percent more than the previous year. Add room and board, and that cost climbs to $30,367.
Often, families resort to these assumptions because the system for financing a college education is too complicated to get their arms around. Education Secretary Margaret Spellings, speaking before a House education panel in May, said the federal student-aid system she oversees "is redundant, it's Byzantine and it's broken."
Consider, for instance, that there are two different systems of federal student-loan distribution, and whether you use banks for these loans or borrow directly from the federal government depends entirely on what college you attend. Then there are the confusing pros and cons associated with the different tax-advantaged college-savings vehicles -- Roth IRAs, 529 plans and Coverdell Education Savings Accounts. Add to that the varied ways your finances will be considered, from the Education Department's assessment for federal financial-aid purposes to some schools' use of their own formula to figure out how to parcel out their own aid.
And now, can you even trust your college's financial-aid office anymore? A nationwide probe by New York Attorney General Andrew Cuomo has led more than two dozen schools to settle claims of deceptive trade practices involving alleged undisclosed payments to fi-nancial-aid officers from lenders they recommended to students.
The unfortunate result of all this is that many families don't even bother trying to find their way through the maze. Instead, they make their assumptions. And those assumptions are often wrong.
Here we deconstruct some of the most common myths.
Myth No. 1
Financial aid comes only in the form of grants and scholarships.
Many families think that "aid" means only money that doesn't have to be paid back -- and that they won't qualify for, based on need. But while scholarships and grants certainly are the best form of financial aid, aid can also come in the form of federal loans that carry favorable interest rates and that can be available regardless of need.
The most common student loan is the Stafford loan. The unsubsidized variety of these loans doesn't require the student to demonstrate need. But they are available only to those who have filled out the so-called Fafsa form, the Free Application for Federal Student Aid, which is something many middle- and upper-income families don't bother to do.
The interest rate on Stafford loans is currently set at a maximum of 6.8 percent. By comparison, the rate on loans from private lenders isn't capped and currently averages around 10 percent at some of the biggest lenders. For a $20,000 loan, that's a difference of about $4,100 over the typical 10-year life of a loan.
Federal student loans also carry more-flexible repayment terms than loans from private lenders. For instance, a borrower who is unemployed or facing economic hardship can request a deferment, which allows the borrower to postpone repaying the loan. For certain loan programs, the interest still accrues and the borrower is eventually responsible for paying it; for others, the government pays the interest during the deferment.
There are even loan-forgiveness programs available for borrowers who take some teaching jobs or who enter public service. The federal teacher loan-forgiveness program allows certain math, science and special-education teachers in low-income schools to qualify for up to $17,500 toward the repayment of their student loans. In addition, many states offer loan-forgiveness programs for their resident teachers. The American Federation of Teachers maintains a list of state-by-state offerings at aft.org/teachers/jft/loanforgiveness.htm. Certain public-service organizations offer their own loan-forgiveness programs, such as AmeriCorps, which will grant volunteers with at least one year of service as much as $4,725 toward loan repayments or future tuition.
One drawback of federal student loans is that there are limits on how much can be borrowed this way. But Congress recently moved to raise the cap for some students. Effective this month, the annual limits on Stafford loans for dependent freshmen and sophomores are $3,500 and $4,500, respectively, up from $2,625 and $3,500. Juniors and seniors can borrow up to $5,500 a year.
If student loans aren't enough to cover expenses, parents of undergraduates are also entitled to federal loans: The PLUS loan has the benefit of not carrying any set borrowing limits -- though the total can't exceed the cost of attendance minus other forms of aid -- and the interest rate is set at a maximum of 8.5 percent. Just remember it's the parent, not the student, on the hook for repayment.
Myth No. 2
The value of my retirement funds and my home will prevent me from getting need-based aid.
Under the federal calculus for distributing aid, retirement plans are completely excluded. So is the home you live in. On top of that, the federal government shelters a certain amount of general parent savings, for retirement purposes. This "asset protection allowance" varies based on age, but for a typical parent of a college-age child, the figure is around $45,000 to $50,000.
Many private colleges use a separate form to determine how much of their own aid to distribute. It also excludes retirement assets, but it does ask for the net home equity of the family's primary residence, capping it at two to three times annual income.
Myth No. 3
I should choose a lender from the list of "preferred" lending companies recommended by my college financial-aid office.
Because of the complexity of the whole aid process, many people trust their college's financial-aid office to provide them with information on loans and point them to the best deals. But the New York attorney general's probe and investigations by members of Congress suggest that lenders haven't always been recommended by financial-aid officers based entirely on students' interests. So you may want to do at least some shopping for loans on your own.
Lenders compete with one another largely by offering "borrower benefits" that lower the costs of their loans. But borrowers should be skeptical of some of these discounts, which can be easy to lose if a student misses a payment.
Citigroup Inc.'s (NYSE: C) Citibank offers a discount of one percentage point on the interest rate of a Stafford loan -- but a student who misses a scheduled payment loses the discount and has to make 24 consecutive payments on time in order to regain it. Nelnet Inc. offers a 3.33 percent reduction on the original principal balance -- if the first 30 payments are made on time. Once the discount is lost, it cannot be regained.
Some deals are more forgiving. Northstar Education Finance Inc., of St. Paul, Minn., offers a month-by-month credit on its student loans that can amount to an annual rate reduction of up to 1.3 percentage points. Students lose the credit only if they fall 60 days past due on a payment. Once the borrower is caught up again on payments, the benefit resumes.
MyRichUncle, a New York lender, cuts one percentage point off the interest rate on its Stafford loan from the start of repayment but charges an origination fee, totaling 1.5 percent of the original principal balance, that other lenders might waive.
Because the discounting formulas vary markedly from one company to the next, it can be extremely difficult to calculate the best deal. Mark Kantrowitz, publisher of FinAid.org, a free guide to financial aid, has come up with a calculator on his Web site that allows consumers to punch in various criteria to compare discounts from the different companies.
Myth No. 4
I'm doomed: I'll have two kids in college at the same time.
The federal assessment of aid eligibility is based on an "expected family contribution" -- the amount of money that parents are expected to shell out, based on their financial picture. That expected outlay stays the same no matter how many kids you have in college at the same time. So if you have two or more kids attending college, your expected contribution is split among them.
The upshot: You are likely to qualify for more aid when you have multiple children in college at once.
Myth No. 5
The federal aid process is bound by a strict formula, and it's virtually impossible to eke any special consideration out of college administrators.
While it's true that everyone applying for federal aid must answer the same questions on the Fafsa, there may be special circumstances worth alerting the college financial-aid office to.
The Higher Education Act, which authorizes federal aid programs, gives college aid officers the authority to make adjustments when they feel it's warranted. If you have a solid case, backed up by documentation, it's definitely worth requesting a "Professional Judgment Review" in a letter addressed to the financial-aid officer and supported by documentation.
For example, if your income looks artificially high in the year that's being evaluated, explain why (perhaps it was due to an atypical bonus) and provide previous tax returns to show what it's normally like. Other instances not covered by the Fafsa and worth alerting the financial-aid office to: high medical costs, a death, private-school tuition for kids not yet in college, divorce, job loss, a big decrease in family income.
Amherst College financial-aid director Joe Paul Case recalls adjusting one aid package as the student's family reeled from the impact of the father's work-related accident, which occurred in the student's sophomore year. The accident left the father out of work for six months. By reassessing the family's finances, Mr. Case says, the school was able to bolster his financial aid through both federal sources and institutional grant money.
New York-based financial-aid consultant Kalman A. Chany had one client this year with household income over $225,000 receiving need-based aid, in part due to high medical costs and an atypical bonus that distorted the client's income stream.
Myth No. 6
Not to worry. Our brilliant/talented/athletic child will get plenty of privately funded scholarships, maybe even a free ride.
Some 87 percent of parents are counting on their children receiving scholarship or grant money, according to a survey by Mathew Greenwald & Associates Inc. for investment-management firm AllianceBernstein LP. The firm polled 1,358 parents last summer, as well as more than 200 college financial-aid administrators. The responses from financial-aid officers told a remarkably different story: 92 percent of them believed that parents overestimate the amount of scholarship and grant money their children will receive.
That is not to say you shouldn't search. In fact, there are several scholarship search services available free online. Sites like FastWeb (fastweb.com) or the College Board's scholarship search service (collegeboard.com) match student profiles to scholarship opportunities.
Myth No. 7
The 529 college-savings plan offered by my state is bound to be the best for me.
Many people's search for a 529 plan stops with their own state's offering. But with all 50 states and Washington, D.C., now offering these college-savings plans, consumers should shop around.
Some states offer their own tax breaks on these plans for state residents, so it is smart to take a good look at your own state plan. But you should also take a hard look at the fees. Most experts say you should pay no more than 1.5 percent of assets in fees and other expenses. High-fee plans can easily cancel out any tax breaks that come with investing in your own state plan.
Morningstar Inc., the Chicago-based financial-information firm, rates the following state plans among the best because of their low fees and the performance of their investments: the Utah Educational Savings Plan, the Maryland College Investment Plan and the College Savings Plan of Nebraska. And you can invest in any one of these three directly, without the help of a broker.