What's New in College Financial Aid?

An economics professor explains 6 ways college financial aid is improving.

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The college financial aid system rivals only the IRS in its complexity. But change is on the way. This week, we've asked visiting blogger Sandy Baum, professor of economics at Skidmore College and special consultant to the College Board, to bring us up to speed on college financial aid. Here are the six most important developments:

1. More generous Pell grants. The Pell grant is the cornerstone of federal student aid: The government provides grants to dependent students with family incomes up to about $50,000 and to independent students with low incomes. The maximum grant is set every year by Congress and has not kept up with the price of college. In 2008-09, the maximum grant was $4,731; in 2009-10, it will be $5,350.

2. Income-based repayment for federal student loans. As of July 1, the federal government has a new system that will limit monthly payments on federal student loans to a reasonable percentage of the borrower's income. Those whose incomes are below 150 percent of the poverty line for their family size will not have any payments due; others will owe no more than 15 percent of the amount by which their incomes exceed this level.

This system is not perfect. The government will pay the interest for some borrowers whose payments don't cover it, but others will see their debts grow as interest accrues. After 25 years, remaining debt will be forgiven, but unless Congress makes a change, this will be a taxable event. And it's important to remember that only federal loans—not loans from private lenders that don't come with a federal guarantee—are covered by this important new program.

3. A simpler FAFSA form. In order to be eligible for federal financial aid—or for need-based financial aid from states, colleges, universities, or other sources—students must complete the Free Application for Federal Student Aid (FAFSA). The Department of Education has announced that this process will become simpler with increased reliance on "skip logic": Students will no longer have to sort through questions that do not pertain to their circumstances. The Obama administration is also requesting that Congress reduce the amount of information required to compute federal aid eligibility so that the form can become even shorter and easier to complete.

4. Transfer of income tax data. Students who apply for aid late enough in the calendar year for their previous year's income tax data to be available will be able to have data transferred directly to the FAFSA. Until and unless the program is expanded, it will not help students applying for aid for the fall semester. However, many people believe that if this experiment is successful, future students will not have to complete separate financial forms at all but will be able to rely on tax data to apply for financial aid.

5. Changing sources of college loans. Many students have to rely on loans to finance part of their college education. Borrowing for college is sensible, since education is an investment that usually pays off for a lifetime. Reasonable amounts of debt can be paid off out of future earnings.

In many cases, it makes sense for parents to take Parent Loans for Undergraduate Students (PLUS), diminishing the amount of debt students will have when they graduate. But when students themselves borrow, the most important thing to know is that federal Stafford loans are a much better bet than private loans. Private loans are widely marketed on the Internet, often with a boast that students can borrow as much as they need without completing the FAFSA, but the interest rates on these loans are likely to be much higher than those on federal loans. Also, the protections for economic hardship that come with federal loans are absent from private loans.

It's easy to get confused about what is actually a private loan. This is because, at least for now, the same private lenders (such as Sallie Mae and banks) provide both private loans and federally guaranteed Stafford loans. Congress is currently debating doing away with private sources of federal loans, but in the meantime, students should be clear about what they are getting.

6. Increasing financial aid (in some cases). Even as colleges and universities, both state and private, are struggling with financial realities, many are nevertheless increasing their financial aid budgets. The school with the highest price tag might actually be the least expensive to attend when financial aid is taken into consideration. And almost all states provide their own grant aid. Even in California, where pervasive stories about the state budget crisis include predictions of the demise of the generous and well-established Cal grant program, valuable state grants are quite likely to remain available to students. Students should be sure to get information about aid from all sources and to find out what they have to do to qualify.

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