If financial aid is based on financial need, then the more debt would be helpful, wouldn’t it? Generally, increasing debt does not increase financial aid. It may even lead to a decrease in eligibility for need-based financial aid.
Financial aid is based on financial need. Financial need is defined as the difference between the college’s cost of attendance and the expected family contribution (EFC). The cost of attendance includes tuition, fees, room and board, books, supplies, equipment, transportation and miscellaneous personal costs. The EFC is calculated based on the information provided on the Free Application for Federal Student Aid (FAFSA).
Debt Secured by Reportable Assets
The financial aid formula that is used to calculate the EFC considers the net worth of reportable assets, which is the market value of the reportable assets reduced by any debts secured by the assets.
Debts that are secured by non-reportable assets, such as mortgages on the family home and car loans, are not considered. Unsecured debts, like credit card debt, are not considered.
On the other hand, mortgage debt secured by investment real estate will reduce the net worth of that real estate. Likewise, a margin loan on a brokerage account will reduce the net worth of the brokerage account.
However, if a home equity loan on the family’s principal place of residence is used to buy a vacation home, the home equity loan does not reduce the net worth of the vacation home because it is secured by the family home and not the vacation home.
Use our Financial Aid Calculator to estimate the expected family contribution (EFC) and your financial need based on income, assets, family size and demographics.
Impact of Debt on Financial Aid
Using a home equity loan on the family home will decrease aid eligibility because the home equity loan is not secured by a reportable asset, but the proceeds from the loan are reported as an asset on the FAFSA.
Using reportable assets to pay off unsecured debts and debts that are secured by non-reportable assets can increase the student’s eligibility for need-based financial aid. For example, using cash in the bank, which is a reportable asset, to pay off credit card debt, which is an unsecured debt, will reduce the reportable assets and thereby reduce the EFC. It is also good financial planning to use low-interest savings to pay off high-interest debt.