How Does a Pending Foreclosure or Short Sale Affect Financial Aid?
How do we answer the question “Do you own your home” on financial aid forms when we are in pre-foreclosure? We are not yet in active foreclosure, but are several years in arrears on our mortgage as we are significantly underwater on our loans and have been unsuccessful so far in getting a satisfactory modification. To that end, we just retained a bankruptcy attorney to expedite the process, and expect to “forfeit” the house in the end either through a short sale or in bankruptcy. — P.G.
Need analysis formulas use a snapshot approach to evaluating assets. Assets are reported on the FAFSA, PROFILE and other financial aid forms based on the status in effect on the date the financial aid application forms are filed. So until the foreclosure is finalized, the home must still be reported as an asset.
(The Free Application for Federal Student Aid (FAFSA) ignores the net worth of the family’s principal place of residence. Vacation homes and other real estate must be reported as an asset on the FAFSA, usually as an investment asset. On the other hand, the family home must be reported as an asset on the CSS Financial Aid PROFILE form and some institutional financial aid forms.)
Applicants cannot anticipate a future change in the status of the asset, not even if foreclosure is imminent. The lender does not take legal possession of the asset until the foreclosure is complete. Applicants also cannot update the assets listed on the FAFSA after the application is filed, even if the status of the asset changes the day after the application is filed.
But a home that is in pre-foreclosure is unlikely to have much of an impact on eligibility for need-based aid. Colleges that consider the family home as a reportable asset always base their assessment on the net worth of the asset. The net worth is the market value of the asset minus any debt that is secured by the asset. The net worth of the asset is also reduced by the amount of any liens against the asset. A home that is in foreclosure or a pending short sale usually has little or no home equity, and so will not have much of an impact on the expected family contribution (EFC).
However, a foreclosure can affect eligibility for the Parent PLUS loan. PLUS loan borrowers must not have an adverse credit history, which is defined as a current delinquency of 90 or more days on any debt or a five-year look-back for certain derogatory events in the credit history. The derogatory events include bankruptcy, foreclosure, repossession, tax lien, wage garnishment or default determination.
Once the foreclosure is complete, it will prevent the parents from borrowing from the PLUS loan program for five years. (The initiation of the foreclosure process is normally treated as evidence of an adverse credit history. But the PLUS loan denial can be appealed based on extenuating circumstances if the family obtains a loan modification or short sale before the foreclosure process is complete.) Including the mortgage in a chapter 7, 11 or 12 bankruptcy discharge will also affect eligibility for the PLUS loan. A chapter 13 bankruptcy does not affect PLUS loan eligibility.
The definition of an adverse credit history does not include short sales. So a family facing foreclosure may prefer to have a short sale to preserve eligibility for the PLUS loan. A deed in lieu of foreclosure is treated the same as a foreclosure, unless it was provided as part of a short sale.
If a dependent student’s parents are denied a Parent PLUS loan because of an adverse credit history, the student will be eligible for the higher unsubsidized Stafford loan limits available to independent students. These loan limits provide an additional $4,000 or $5,000 per year in unsubsidized Stafford loan eligibility, depending on the year in school. Some parents prefer to have their student qualify for the higher unsubsidized Stafford loan limits, since the Stafford loan is a student loan, not a parent loan. However, the increased unsubsidized Stafford loan limits might not be enough if the student is enrolled at a high-cost college.