Higher Ed Struggles as Economy Falters

Competition for financial aid and seats at the most affordable schools is fierce.

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In economic storms past, the nation's college campuses often served as a lifeboat. Young people studied while waiting out hiring lulls, and the unemployed went back to learn new skills. Not this time. Declining house values, investment market meltdowns, credit tightening, government budget shortfalls, and rising joblessness are causing unprecedented turbulence for the nation's colleges and students.

There are still enough grants and loans for most students to afford at least a community college. And top students will still most likely qualify for plenty of aid from wealthy schools. But the financial crisis appears to be pricing some students out of some schools, turbocharging the demand for financial aid, and heightening the competition for seats at the lowest-priced and most generous schools. A survey of more than 500 private colleges in October revealed that 46 percent of schools report some students halting studies or switching to part-time status for financial reasons.

It will get worse. Millions of parents and students are quickly recalibrating finances and ambitions, just like the Kagans of Freeport, Maine. Daniel Kagan, a lawyer, has high hopes for son Max—a high school senior who has learned French, Turkish, Arabic, and Hebrew—and daughter Rachel, 15. But after their college savings account fell by about 30 percent in the past month, he further urged Max: "Why not give yourself options beside the prestige schools" and shoot for lower-cost schools as well as lower-tier schools likely to award him merit scholarships? The ripples of such decisions are already being felt in Washington, where applications for federal aid have jumped 16 percent. And they are reaching across to California, where seven of the most popular state universities expect to be so swamped with applicants that they are cutting off most applications after November 30.

Financial aid officials say students and parents should prepare for four unhappy developments:

Tuition hikes. Declining tax revenues and endowment returns will very likely spark schools to raise tuition. Rhode Island has already announced it will hike tuition at its public colleges in January by more than $200. It is also cutting the size of the average grant it awards by more than $125. Many other states could follow suit by next September.

Decreased savings. Because of higher living costs, about a third of all parents surveyed this summer said they had reduced or stopped contributing to a college savings account. Many of those who had invested their money for their children have watched in horror as their "529" accounts began to plummet. The silver lining: While most 529s haven't been keeping up with tuition inflation, at least they didn't crash as badly as the general market.

Smaller grants. Some scholarships may be cut next year. The demand for Pell grants is on a pace that will put the program about $3 billion over budget next year. If Washington doesn't scrape together enough extra money, the size of next year's Pells could fall. Many charities and corporations that in recent years have awarded a total of more than $3 billion in scholarships annually are also planning to reduce scholarships. "Unless a miracle in the market occurs by next April," the McConnell Foundation, which handed out 37 big scholarships to students from rural northern California this year, will offer only about 30 next spring, says David Tanner, the foundation's scholarship program officer.

Fewer loans. Many lenders, trying to conserve cash and limit risk, are approving applications only for federally backed education loans. They are rejecting a growing number of applications from those hoping to raise extra money by tapping their homes' equity or taking private loans. At the Vermont Student Assistance Corp., the employees who answer calls from parents hoping for private loans try to persuade parents to opt for federal loans instead. Students can borrow at least $5,500 at a maximum of 7.25 percent through the federal Stafford program. And those who need more than the Stafford maximum can ask their parents to take out a fed-eral PLUS loan at a fixed rate of about 9 percent to cover the rest of the student's cost of attendance.