FAFSA REVIEW

Frequent reminders of essential information are necessary and important. That is brought to my attention when, in conversation with a parent, the mystery and misunderstanding of FAFSA come to the front. This blog is not exhaustive in its treatment of FAFSA. I have written other blogs on the topic, including 8 common mistakes to avoid when completing FAFSA. You can read that post by clicking here. This article is the reminder you want of the basics about FAFSA.

• FAFSA Free Application for Federal Student Aid. The application is free, not necessarily will the financial aid be free. Reputable counselors (like your author) do not charge a fee to help families complete FAFSA. Other consulting services do come with a fee.
• It's a data collection tool. FAFSA does not award any financial aid. There is a Student Aid Report (SAR)generated as FAFSA is completed and submitted. However, even those amounts are not set in stone. The data you provide is sent to any college you list within the FAFSA form. Those college financial aid offices make the actual awards decisions.
• A loan is a loan. Every FAFSA SAR I have seen includes student loans. As with any other loan, there is paperwork to be completed, by the student, within a deadline. The requirements include signing off on a financial education module, signing a Note of Indebtedness, and signing a consent to assign the loan dollars to the college of your choice. Those dollars will be deposited in your student account, and the college will deduct appropriate charges. The balance (if any) is yours to do with as you please. There are origination charges (temporarily waived for COVID-19 relief), and interest charges that may be subsidized (i.e. paid for) by the U.S. Treasury Department. Most loans, however, are unsubsidized. That means the student owes the interest as well as the principal sum.
• Annual renewal is required. You complete a FAFSA every year for which you seek financial aid for college. You create an account, including a username and password; challenge questions; a Save Code; and double authentication (email and cellphone). Because of those features, subsequent applications are pre-populated. Often, the only change required is to update the family's financials.
• There is a limit. Undergraduate students may borrow, on their own signatures, up to $27,000; with an extra $4,500 in special circumstances, or $31,500 maximum. Eligibility and disbursement are $5,500 for year one; $6,500, year two; $7,500 year three; and $7,500 year four. The additional $4,500 is not guaranteed, and can be requested at the end of year four. Horror stories you read about unimaginable student debt are because of private loans, which in most cases, require a co-signor.
• Interest rates are attractive. Direct Student Loans interest rates are low, and change every year, effective July 1. The interest charged is linked to the Ten-Year Treasury Note interest rate. Each annual loan, therefore, has its own interest rate. Each annual loan is a separate contract. For a student graduating in four years, and taking advantage of student loans, he or she will have four different loans, each with its own interest rate. Those four may be consolidated at a yet new interest rate (one that is typically favorable).

Takeaways are: FAFSA gives no money, the colleges do. FAFSA aggregates data and sends it where you say. FAFSA is an annual application. On their own signatures, undergraduates can borrow a maximum of $27,000 (and with approval, $31,500). Interest rates favor using the loans. Remember, you finance every purchase you make: either borrow and pay interest, or pay cash and lose interest.

The news is filled with stories warning about student debt, lamenting student debt, highlighting political promises to forgive student debt. I have yet to see a news story that reveals the true cost of a college education with or without loans.

One factor in understanding true cost is to add in opportunity cost. Another factor is missed income because a student took more than four years to graduate. A third factor is the one most people think about, interest rates.

Let's look at them in reverse order. Interest rates on Direct Student Loans are actually as low as current mortgage rates; currently 2.75% for students borrowing for the academic year 2020-2021 (FSA Student Loans). Furthermore, undergraduates hit a borrowing ceiling of $27,000 over four years. A $27,000 loan at 2.75%, amortized over ten years will incur a monthly debt service of less than $276.00. That is not crushing debt service for a college graduate.

Are you wondering, then, where all the stories come from about crushing student debt? The answer is found when students "need" to borrow beyond the $27,000 federal, direct loan. Then they go into the private lending market. Sallie Mae is a big player in that arena, and interest rates there can be as high as 12%. Here's an example of what can happen:

• Wilma decides she must attend "Bigtime U" at out-of-state rates of $31,750.

• $31,750 multiplied by 4 years is $127,000. She borrows $27,000 @ 2.75% using the Direct Student Loan privileges. The remaining $100,000 is picked up at Sallie Mae, and let's say her consolidated loan interest rate is fixed at 10%; amortized over ten years.

• Total, monthly debt service is $1,586.00. Yes, that is one thousand five hundred eighty-six dollars per month for ten years ($1,310 to Sallie Mae; $276 to Federal Student Aid).

• Furthermore, her Sallie Mae loan required a co-signor. So now a $100,000 obligation is sitting on mom's, dad's or grandparent's credit report.

We're not done. Hang in there. Keep reading.

If Wilma takes five years to graduate with a B.S. in something, that fifth year will cost her the full, out-of-state tuition, plus other costs; let's say $50,000. In addition to borrowing another fifty grand at current interest rates, she will not be earning $45,000 in her first career track job (The 4-Year Myth). Therefore, the cost of the fifth year is actually $95,000; nearly equal to the cost of the first four years. We have previously written a 3 part series on The 4-Year Myth. You can click here to read part 1,
part 2,
and part 3.

Finally, factor #3 is opportunity cost. Let's keep this simple and not even factor in the interest Wilma is paying. Let's just look at the principle sum of $177,000 ($127k for years 1-4, and $50k for year 5). If Wilma had put that amount of money into an investment account earning a modest 5% interest, compounding annually during her working career, she would have, at age 67, more than two million dollars to live on in retirement. I hazard a guess to say she will struggle to achieve that with her college degree, and $1,586 per month debt service.

You can find a better path. Be a smart consumer.