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College Financial Aid - Need-Based Aid, Federal Aid, State Aid, Institutional Aid, Financial Aid and Affordability

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Despite the fact that college tuition rose much more rapidly than either consumer prices or family incomes during the 1980s and 1990s, few college students paid the full cost of higher education during this period. Those who attended public colleges and universities paid relatively low tuition, with state taxpayers funding much of the cost of running these institutions. Students enrolled in private colleges and universities generally paid significantly higher tuition, but that tuition was rarely high enough to cover costs, which have traditionally been subsidized by private donors.

Over half of all undergraduate students–and over 70 percent of those who attend full-time–receive financial aid to help pay their tuition. Most of this aid, which adds up to almost $70 billion a year, comes from federal or state governments or directly from the institutions. It may be in the form of grants (which do not have to be repaid), loans, or work. Some aid is based on financial need, while other aid is awarded on the basis of academic qualifications, athletic ability, or other personal characteristics.

Need-Based Aid

Historically, the driving force behind student financial aid has been the goal of providing access to higher education regardless of a student's ability to pay. The value placed on equal opportunity in American society, combined with the role of education in determining occupational and financial success, has created strong support for devoting both public and private funds to subsidizing students who would otherwise not have the means to continue education beyond high school. Although a decreasing proportion of student aid is based purely on financial circumstances, need-based aid remains the core of the financial aid system.

"Ability to pay" and "financial need" are not precise concepts, but an elaborate system has developed to direct funds toward those who need them most. The current approach to measuring need dates back to the mid-1950s, when a group of colleges established the College Scholarship Service of the College Board. They developed a standardized system of measuring family ability to pay, which allowed them to distribute their funds more equitably. This system has evolved over time and continues to guide the financial aid systems of many private nonprofit colleges and universities. Since 1986, Congress has legislated a formula for determining eligibility for federal need-based aid funds. This formula also provides the basis for aid allocation in many states.

Under both the congressionally mandated Federal Methodology (FM) and the formulas used by most colleges and universities, need is defined as the cost of attending college less the Expected Family Contribution (EFC)–which is determined by the need-analysis formula–a federal methodology that determines how much families/students can afford to pay and is used to allocate federal funds. (For students who are not dependent on their parents, only the student's financial resources are considered.) Students apply for aid by filling out the federal government's Free Application for Federal Student Aid (FAFSA), as well as any additional forms required by the schools to which they are applying. FM focuses on current income levels, family size, and the number of family members in college, though many institutions collect additional information from applicants and measure financial strength using a formula that, like the College Board's, relies on both income and assets in addition to relevant family circumstances.

Federal Aid

The federal government provides about three-quarters of its $48 billion of student aid in the form of loans. Half of this amount is in the form of subsidized loans to students. Students determined through the Federal Methodology to be eligible for need-based aid either borrow directly from the government (William D. Ford Direct Loans, usually called simply Ford Direct Loans) or take federally guaranteed loans from banks or other private lenders (Federal Family Education Loans, or FFELs). The government pays the interest on these subsidized loans while the student is in school.

In the 1990s, non-need-based loans became an important component of the federal student aid system. Forty percent of federal education loans are now in the form of unsubsidized student loans. Introduced in 1992, these loans are available without regard to financial need, and interest accrues on them during the college years. The federal government also provides non-need-based loans to parents of undergraduate students.

The largest federal grant aid program, the Pell Grant, is the main source of aid targeted directly at the most economically disadvantaged students. By the year 2000, almost 4 million students a year received an average of about $2,000 a year under the Pell program, which provided maximum grants of over $3,000. Funding for Pell Grants increased about 15 percent in real terms during the 1990s, but the growth was almost entirely in the number of recipients, not in the size of the average grant. In 2000, the maximum grant covered less than half as much of the cost of attending both public and private four-year institutions as was the case in the mid-1970s.

In addition to a variety of other smaller grant programs, the federal government provides about $1 billion in work-study aid, which subsidizes student employment during the academic year. Like Pell Grants and subsidized student loans, work-study funds are need-based and are distributed on the basis of eligibility as determined by the Federal Methodology.

Since 1998, the federal government has supplemented these explicit student aid programs with taxbased subsidies to college students. The Hope Scholarship and Lifetime Learning Tax Credits are nonrefundable tax credits that reduce the federal income taxes of students or their parents who are paying tuition. These credits benefit those who earn enough income to pay income taxes, but whose income falls below the legislated maximum. In other words, they are directed primarily toward middle-income students. The subsidies provided by these tax credits exceed the amount of federal grant aid to students.

State Aid

State subsidies for higher education come in the form of the relatively low tuition levels enjoyed by all students at public colleges and universities. However, states also have grant programs to assist students in covering their college costs. State grant aid grew much more rapidly than federal grant aid during the 1990s. By the year 2000, nine states spent less than $2 billion a year on student aid, but South Dakota was the only state with no program in place. At the other end of the spectrum, five states provided more than $200 billion a year to their students.

As is the case with federal student aid, the proportion of state aid that is based on financial need was smaller in 2000 than it was in 1990. Georgia has set a national example with its merit-based program and many states appear to be following suit. Nonetheless, more than 80 percent of state aid is dedicated to undergraduate need-based programs, and many states still have only need-based grant programs.

Institutional Aid

Financial aid funded directly by institutions grew very rapidly in the 1990s, particularly in private non-profit colleges and universities, but also in the public sector. By 2000, about 20 percent of total student aid and almost half of total grant aid came from institutions. Financial aid, which used to be viewed only as a subsidy to students, is now frequently seen as serving multiple purposes. In addition to using it to make college affordable for more students, many colleges and universities are devising strategies to use aid dollars to attract particular types of students by influencing students' choices among institutions. Many schools have increased the proportion of their grants and scholarships they award to students based on academic or other personal qualifications. On public campuses, over half of the student aid is now based on criteria other than need. However, at private colleges and universities, about 80 percent of the student aid is still based on financial need as determined by a need analysis formula.

Financial Aid and Affordability

Student aid covers more of the cost of college for full-time students than for part-time students, and it covers more for lower-income students than for higher-income students. Grant aid reduces the amount students have to pay for education, while loans reduce liquidity constraints but impose repayment burdens after college. In other words, because of financial aid, different students pay very different amounts for the same educational experience. The student aid system is complicated, with aid coming from a variety of different sources and allocated based on a variety of different criteria. While it is difficult to measure precisely the impact of the aid system, it is clear that the availability of student aid has significantly increased the number of students who have the opportunity to continue education after high school, and also broadened the choice of institutions available to many students. Nonetheless, there is considerable evidence that financial aid has not succeeded in making higher education affordable for all qualified low-income students.


THE COLLEGE BOARD. 2000. Trends in Student Aid, 2000. Washington, DC: College Entrance Examination Board.

KING, JACQUELINE. 1999. Financing a College Education: How It Works, How It's Changing. Phoenix: American Council on Education/Oryx Press.

NATIONAL ASSOCIATION OF STATE STUDENT GRANT AND AID PROGRAMS. 2000. 30th Annual NASSGAP Survey Report. Albany, NY: National Association of State Student Grant and Aid Programs.

NATIONAL CENTER FOR EDUCATION STATISTICS.2002. Federal Support for Education: Fiscal Years 1980 to 2001. Washington, DC: U.S. Department of Education.


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