How Home Equity and Other Assets Affect Financial Aid
With college costs at an all-time high, it is no wonder that parents are looking for ways to increase their financial aid eligibility. There is a lot of advice flying around the rumor mill about ways to get more financial aid—some of it true, a lot of it false, and much based in kernels of truth. Among these questionable pieces of advice is the common refrain that you ought to pay off your house in order to get more financial aid.
Like many words of financial aid wisdom garnered from one’s cousin, neighbor, or even the internet, this advice is based in some reality. It is true that the federal financial aid formula excludes your home equity from its calculations. Therefore, if you had $100,000 burning a hole in your pocket, it would be better for federal financial aid purposes to have this money in your house than in an asset included in the aid formula, like a bank account. Unfortunately, this strategy of “hiding” money in your home is not the magic wand many hope it will be, and it often ends up backfiring on families for a few different reasons.
Home Equity Is Not Excluded At All Schools
While home equity is not reported on the FAFSA, the application utilized to award all federal aid and by the vast majority of colleges to award their own institutional aid, there are about 400 colleges—including many of the most popular private schools—which request an additional aid application called the CSS/Financial Aid Profile. The Profile form does require you to report your home equity, and most of the colleges that use the Profile don’t look at your home equity any differently than any other asset. Home equity of $100,000 feeds into the financial aid formula just like $100,000 of cash would, so paying down your house brings absolutely no benefit at many popular colleges.
Assets Don’t Hurt Much Anyway
In addition, families should understand that parental assets have a limited effect on financial aid calculations as it is. The financial aid formula includes an asset protection allowance that sets aside the first approximately $30,000-$40,000 held by the parents (depending on their age) as unavailable for college. Beyond that, parents are expected to contribute at most 5.7% of any additional assets to college each year. So for every $10,000 you have in the bank beyond your asset protection allowance, you may lose out on only $570 of financial aid—a minimal loss. The financial aid formula is really driven by a family’s income, and if your income is high enough that it has allowed you to accumulate enough money in the bank that your assets may significantly affect the aid calculations, your income alone is probably too high to qualify for need-based financial aid. “Hiding” your money in your house is, at best, unnecessary.
Loss of Liquidity
In the worst-case scenario, paying off your house can actually become counter-productive. There is a significant trade-off involved with paying down your home: all of that money that you had sitting in the bank, available to pay the college bill, is now tied up in your house. If you actually need to access those funds to pay tuition, you now have to borrow them from the bank, paying whatever interest rate the market determines. Many families find that this loss of liquidity is the most significant repercussion of paying down their house, while any financial aid gains are minimal.
As you can see, paying off your house is not necessarily the miracle solution to your college payment dilemma that it is often projected to be. While some families do benefit from this college finance strategy (it can open up cash flow previously devoted to mortgage payments and may increase aid eligibility for moderate-income families applying to colleges utilizing the FAFSA application only), it is not a magic bullet destined to destroy the college payment obligation for every family. Families should consult with a true college finance expert—not their co-worker’s mailman’s sister—before undertaking any significant financial moves designed to increase aid eligibility.