How do outstanding loans affect future financial aid awards for my
children? Is there any advantage to trying to pay them back early
(other than less interest)? Are they counted towards my outstanding
debt thereby potentially increasing my aid package?
— Linda H.
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Most forms of consumer debt, including auto loans and credit card
debt, are ignored by the Free Application for Federal Student Aid
(FAFSA). Loans are considered on the FAFSA only if they are secured by
an asset that is reported on the FAFSA. In such a circumstance the
value of the asset is reduced by the debt against the asset. For
example, the net asset value of a stock market investment is reported
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on the FAFSA by subtracting any margin loans from the investment's
market value. Similarly, the value of investment
is reduced by the amount of any mortgages secured by that real
estate. But a mortgage against your home (your "principal place of
residence") does not count — even if it was used to buy the
investment real estate — because it is secured by your home, and
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the net asset value of your home is not reported on the FAFSA.
This means that there is generally no advantage to having outstanding
loans. Money in a bank or brokerage account counts against you, while
most consumer debt does not help. You will not get more student aid
because of your debt.
Using your savings to pay off your debts might improve your
eligibility for need-based financial aid. Use a financial aid
calculator like the one on FinAid to see if it will affect your
expected family contribution (EFC). Sometimes it improves the EFC and
sometimes it has no effect, depending on family income and the amount
of reportable assets.
However, even if paying off your high-interest loans doesn't improve
your eligibility for need-based financial aid, it can still save you
money. For example, let's suppose that you are earning 1% interest on
your bank account balance but paying 14% interest on your credit card
debt. Each year you are earning $10 in interest for every $1,000 in
your bank account, but paying $140 in interest for every $1,000
you owe on your credit cards. Paying down the credit card balance by
$1,000 will net you $130 in savings a year, tax fee.
Keep 3-6 months salary in a rainy day fund for emergencies, but
otherwise use excess cash to pay down debt. You should pay off your
highest interest debt first in order to maximize the savings. Usually
this is credit card debt.
Try to avoid running up the balance on your credit cards after you've
paid them off. Cut up the cards if necessary to avoid the
temptation. Only charge as much on your credit cards as you can afford
to pay off in full when you get the monthly bill. Otherwise you are
spending beyond your means.
I am trying to go back to school. I have a student loan in
default. They have been taking deductions out of my paycheck. What are
my financial aid options if any?
— Cedric C.
Borrowers who are in default on a student loan are ineligible for
further federal student aid.
There is, however, a one-time opportunity to rehabilitate your loans
by making 9 out of 10 consecutive on-time full voluntary monthly
payments. Voluntary payments do not include any payments obtained
through wage garnishment or the offset of federal income tax
refunds. You will regain eligibility for federal student aid after you
have made 6 consecutive payments. After you have made all 9 payments
the default will be removed from your credit history.
You can also regain eligibility for federal student aid by paying off
your student loans in full.