Financial Aid Definition

College financial aid is money given by the Federal and State governments and the colleges to help students pay for the cost of a college education.

Two Types of Financial Aid

There are two basic types of financial aid:

  1. Self-help aid, which consists of interest-subsidized loans and work-study; and,
  2. Gift aid, which consists of grants and scholarships. This money does not have to be repaid.

Two Determining Factors

The amount and type of financial aid is based on two factors:

  1. The merit of the student (scholastic, athletic, musical, etc.); and,
  2. The financial need of the student. By far, this is the most important factor in determining financial aid. Most of the financial aid given by the Federal and State governments is based on the financial need of the student. Also, most of the financial aid given by the colleges is need-based.

Note: The Ivy league colleges and other highly selective private colleges base almost all of their grants and scholarships on the financial need of the student and not the student’s merit.

Needs Analysis

Needs analysis is the process of determining the financial need of the student. It is calculated using the below formula.






Note: If a student has no financial need (or adjusted financial need) the student will not be eligible for most types of federal, state, or college financial aid.

Needs Analysis Example 

   COA                        $35,000

  EFC                         $17,000

= NEED                     $18,000

–  RESOURCES     $1,000

= ADJ. NEED         $17,000

Example: If the cost of attendance (COA) at a particular college is $35,000 and the “expected family contribution” is calculated to be $17,000, the “financial need” of the student would be $18,000. In this case, the student would be eligible to receive $8,000 in financial aid. Whether the student receives a financial aid award letter for the entire $18,000 is up to the discretion of the individual college. Nonetheless, the financial aid eligibility of the student is directly related to the financial need. If the student had other “resources” to help pay for the college cost, the financial need would be reduced on a dollar-for-dollar basis for these resources. In this example, assume the student had received a $1,000 private scholarship from the local Chamber of Commerce. Since private scholarships (scholarships that are not given from the college) are considered a resource, the $1,000 scholarship would reduce the financial need to $17,000. This means the student would now be eligible for only $17,000 in financial aid from the college.

A closer look at the individual elements of this formula is warranted to fully understand exactly how the formula works.

Cost of Attendance

Cost of attendance (COA) consists of tuition, fees, room and board, books and supplies, personal expenses, cost of a computer, and transportation to and from college. The college must furnish the COA information (Beware of the accuracy of this “advertised” information: Colleges may omit the cost of personal expenses and transportation to and from college.) The “true” COA includes the expense of travel to and from college and personal expenses, such as clothing and entertainment.

The COA of a college can be computed using the formula:

COA = Financial Aid Award + PLUS Loan Eligibility.

The cost of attendance formula is not the same for all types of students. For students who are less than half-time their COA only includes tuition and fees, an allowance for books, supplies and transportation, and an allowance for dependent care expenses. Incarcerated students can only include tuition and fees, and if required, books and supplies. This type of student is unable to receive an SFA loan, and if the student has been incarcerated in a federal or state penal institution, they may not receive a Pell Grant. Students who take correspondence classes only can include only the tuition and fees in their COA. If this student is fulfilling a required period of residential training, their COA can also include required books, supplies, travel, and room and board costs specifically incurred. For a student who is taking classes through telecommunications courses, no determination can be made on the cost of their attendance. However, the cost of their equipment, either through rental or purchase, cannot be included in the COA. If the Financial Aid Administrator uses their professional judgement and determines that a course of instruction offered through telecommunications results in a substantially reduced COA to the student, the FAA must reduce the student’s eligibility for grants, loans, or work-study assistance.

Note: The student loan interest deduction requires that the loan proceeds must be used for qualified education expenses. The definition of these expenses is the total COA as described in this section. Hopefully, the colleges will be required to provide the true COA figures to the parents for not only this tax deduction, but also to enable parents to determine the true COA for the college. This should make comparisons of colleges clearer for the parents and student.

Note: In most cases, the student cannot affect the COA that is set by the college. However, if the student can convince the financial aid officer at the college that the student has special needs, such as extraordinary medical or handicap needs, the financial aid officer may increase that individual’s COA to reflect the increased costs associated with the special needs.

Note: Childcare costs could be considered as part of the COA. The financial aid officer should be notified of these costs and, if necessary, an appeal should be made to add these costs to the COA.

Observation: As an alternative to the expensive American private colleges, some students obtain a college education at Canadian colleges. The cost of college in Canada may be considerably less than in America and the student can get an international experience.

Note: If a student is considering attending an out-of-state public college, there can be a substantial increase in COA because of out-of-state tuition fees. Unfortunately, for the student the out-of-state public colleges often do not meet this additional cost with additional financial aid funds. Some states have reciprocal tuition agreements with their neighboring states. Should this be the case, this out-of-state tuition is reduced or eliminated. However, if the student plans to attend an out-of-state public college that does not have a reciprocal tuition agreement with the student’s state of residency, the student has the option of trying to establish residency in the state where the college is located; this can be difficult. 

Expected Family Contribution

Expected Family Contribution (EFC) is how much the family is expected to contribute to the total cost of college for that singular year. EFC can be thought of as the family’s “college tax liability.” The EFC is computed by using the family financial data submitted on financial aid application forms.

There are two formulas that can be used to calculate the EFC:

  1. the Federal Methodology formula; and,
  2. the Institutional Methodology formula.

Expected Family Contribution (EFC) Formula

Parents’ Contribution from Income (PCI)

+ Parents’ AGI

+ Untaxed Income & Benefits

–  Living Allowance

–  Federal Income Taxes

–  Social Security Taxes

–  State Taxes

–  Employment Exp. Allowance

x 22%-47%

= PCI 

Parents’ Contribution from Assets (PCA)

+ Parents’ Assets

–  Asset Protection Allowance

x 5.6%


Student’s Contribution from Income (SCI)

+ Student’s AGI

+ Untaxed Income & Benefits

–  Federal Income Taxes- State Taxes

–  Social Security Taxes

–  Income Allowance

x 50%


Student’s Contribution from Assets (SCA)

+ Student’s Assets

–  Nothing

x 20%


Note: The rates used to assess the parents’ income and assets are graduated rates and the rates used to assess the student’s income and assets are flat rates.

Federal Methodology Formula

The Federal Methodology Formula (FM) is a federal formula used to calculate the EFC. It is used by every accredited college in the United States to determine how much federal money can be disbursed by the college to cover the student’s COA. Most states also use this formula as a basis to distribute state financial aid funds.

Institutional Methodology Formula

The Institutional Methodology formula (IM) is an alternative formula used by some private colleges to calculate an Institutional EFC. The College Board determines this formula and makes annual changes to it. The IM formula is calculated from the information filed on the PROFILE application.

This formula assesses the family home, the family farm, siblings’ assets and other items that the Federal Methodology does not assess and is calculated prior to the disbursement of the college’s own funds. Since the IM takes into consideration additional factors, the EFC calculated by this method is usually higher than under the Federal Methodology.

The client’s EFC should be calculated using both the FM and IM formulas. This is to prevent an unpleasant surprise for the client who only has the EFC calculated using the FM formula and has a student that attends a college that uses the IM formula.

Dates of Assessment

Incomes of the parents and the student are assessed using year-end data from 2 years prior (commonly called the “base year”) to the year when the student will be entering college. For the 2018-2019 college year, income will be assessed using the 2016 calendar year information (e.g., Adjusted Gross Income on the 2016 1040 tax return).

Assets of the parents and the student are assessed as of the date the financial aid application forms are signed. (e.g., October 10, 2017 for the 2018-2019 college year).

Since a student will file the final financial aid application form in the spring of the junior year in college, the income the student makes in that calendar year will not affect the student’s eligibility for financial aid. Therefore, the student can have unlimited income during that calendar year without a reduction in financial aid eligibility. It may be a tax benefit for the student’s parents or grandparents to shift income to the student during this period.

Example: On October 15, 2017, Judy, a junior in college, will file her  2018-2019 FAFSA financial aid application form for her senior year in college. Her financial aid eligibility for her senior year in college is based on her income for the calendar year 2016. In the summer of 2017, she received a gift of highly-appreciated stock from her parents. She will sell the stock and report a capital gain of $18,000 on her 2017 income tax return. Since the income is reported in 2016, the income had no effect on her financial aid eligibility and the family tax savings was $1,800, a $3,600 capital gain tax (if reported by her parents) minus $1,800 paid on her tax return.

Qualifying Parameters

To get a rough estimate of the EFC produced by various combinations of income and assets, reference the below table. (The table below assumes the student has income of less than $6,570 and there are no assets in the student’s name.)

Parents’ Income   $100,000   $100,000   $150,000   $150,000   $150,000   $150,000   $200,000   $200,000
Assets   $100,000   $100,000   $100,000   $100,000   $200,000   $200,000   $100,000   $100,000
Number in College       1       2       1       2       1       2       1       2
Number in Family       5       5       5       5       5       5       5       5
EFC $20,200 $10,100 $39,700 $19,850 $45,300 $22,700 $53,800 $26,900


Note: In the above table, note the drastic drop in EFC (the EFC is on a per student basis) if there are two members of the family in college. Also note that if the COA at a particular college is less than the EFC shown in the table, the child will not be eligible to receive financial aid at that particular college.

Caution: A financial advisor should not assume that a client who does not appear to qualify for financial aid based on the above table will not currently, or in future years, qualify for financial aid. Future events, such as death, disability, divorce, or unemployment, may make a client eligible for financial aid. Also, if the student qualifies as an “independent student” , the income and assets of the parents are not considered in the EFC calculation.


Financial Need

Financial Need is the total amount of financial aid that the student is eligible to receive. The total amount of financial aid received by the student usually will not exceed the financial need of the student. When analyzing the student’s need, some colleges will meet 100% of the student’s total financial need, and other colleges will meet only a percentage of the student’s total need. Private colleges tend to fill the financial need with a higher percentage of gift aid than do public colleges. The private colleges do this to put their cost on a level playing field with the cost of public colleges in order to attract the better students.

The below comparison illustrates how two specific colleges will fill the need of a student. Notice that the “true cost” of a private college is considerably less than the published “sticker price”.

Public vs Private College

Public                                                                                Private

   Total Cost                           $28,000                        Total Cost                              $52,000
–  EFC                                        $19,000                    –  EFC                                           $19,000
= NEED                                   $9,000                       = NEED                                       $33,000

% Need Met                                 80%                      % Need Met                                  100%

Financial Aid Eligibility $7,200                         Financial Aid Eligibility     $33,000

Gift Aid (15%)                     $1,080                        Gift Aid (70%)                         $23,100

Self Help (85%)                  $6,120                        Self Help (30%)                       $9,900

“Out-of-Pocket Cost”    $20,800                     “Out-of-Pocket Cost”         $19,000

“True Cost”                          $26,920                     “True Cost”                               $28,900

***” True Cost” = (Total Cost – Gift Aid)

***” Out-of-Pocket Cost = (Total Cost – Financial Aid Eligibility)

Note: The above comparison illustrates how two specific colleges will fill the need of a student. Notice that the “true cost” of a private college is considerably less than the published “sticker price.”

Student Resources

Student Resources are sources of funding outside the family’s income and assets the student has available that the college feels the student can use to pay for college. The colleges will lower the Financial Need of the student on a dollar-for-dollar basis for the amount of any resource of the student. Some common types of student resources are:

  • private scholarships or grants;
  • cash gifts paid directly to the college for tuition (from outside the immediate family, such as tuition paid by grandparents);
  • employer-provided education assistance programs; or,
  • any other funds that the college feels that the student has at the student’s disposal to pay for college, such as ROTC assistance (scholarships and subsistence), Veterans/VEAP/Reserve or Guard benefits, or Vocational Rehabilitation benefits and subsistence.

Summary of Financial Aid Basics

The two types of financial aid are:

  1. gift-aid; and,
  2. self-help aid.

The amount and type of aid given to a student depends on the financial need of the student. The financial need is determined by the needs analysis formula.

The key element in this formula is the “expected family contribution” or EFC. The EFC is comprised of the parents’ contribution from income and assets and the student’s contribution from income and assets. All colleges use the Federal Methodology EFC formula as a basis to distribute Federal and State financial aid funds and the Institutional Methodology EFC formula is used by some private colleges as a basis to distribute their institutional funds.

Colleges meet the financial need of the student in varying percentages. They also fill the financial need with varying percentages of gift-aid and self-help aid. Private colleges tend to meet a higher percentage of a student’s financial need and with a higher percentage of gift-aid than do public universities. They do this in order to compete for students.

“Resources” of a student reduce the financial need of the student on a dollar-for-dollar basis.