Understanding the College Pricing Ladder

Image Credit: Rao Advisors LLC

By Rajkamal Rao

May 1 is the deadline for students to accept offers of admission from colleges and lock in their seats. While most families have already sent in their deposit amounts, there are several who are still struggling with how to balance multiple offers of admission. Invariably, the struggles relate to the costs of college attendance (COA).

In the United States, the COA is collectively borne by the family, the student, the university or college, the state government (in the case of public colleges), the federal government and private entities which make merit scholarship awards, such as those associated with the National Merit Scholarship program. The degree to which each of these external parties assumes financial responsibility will determine how much the family pays.

Nearly all financial awards are need-based. External merit scholarships are extremely rare, and when given out, are rather small. Most are one-time. Determining financial need is a complex exercise and is facilitated through huge black-box websites - the Free Application for Federal Student Aid (FAFSA®), run by the U.S. Department of Education, and the College Scholarship Service (CSS), run by the College Board. 

These websites employ complex algorithms and business rules. They take into account numerous family financial situations such as the age of parents, income, savings, debt, size of household, number of college-going students, assets, alimony payments, and other parameters. The sources for this information are the tax returns filed by the parents (and the student, if the student is employed). Deliberately filing erroneous information, with the intent of extracting a more favorable need-based determination, is a violation of numerous federal and state laws.

The engines make several assumptions. If a family has an annual income of X, the programs will automatically assume that total family savings will be a multiple of X. For families with lower incomes, up to $65,000, the multiple is less than 1. For families with higher incomes, the multiple is greater than 1. If your family has savings higher than this amount, your financial needs are deemed to be less. In effect, both FAFSA and CSS tend to penalize families for saving more and reward those who don't save as much.

The College Pricing Ladder

The top line for the college cost of attendance is the sticker price. But just like when shopping for a car, just about no one pays the sticker price.

How much your family pays for college is unique, much like an airline seat. It is dependent largely upon FAFSA's and CSS's determination about how much both programs think your financial need is.

Federal grants and college cash awards, funded through college endowments, bring down the sticker price. These are monies which do not have to be repaid, so they're a great bargain. The so-called "full ride" awards are essentially cash awards from colleges which will not charge tuition fees at all. Tax credits and deductions make up the remaining components of the "free money" bucket.

The "Net Price" is simply the difference between the sticker price and the discounts the family has been offered. Remember that the family is ultimately responsible for the Net Price.

Working your way up from the bottom of the image above, the first number is called the Estimated Family Contribution (EFC). This amount is a result of the FAFSA engine's computation when you file your FAFSA application - and is nonnegotiable unless family circumstances for costs and income change. The EFC is the minimum the family must pay, kind of like a deductible when filing an insurance claim.

The difference between the EFC and the Net Price is called the Gap amount. The Gap is always the responsibility of the family. It can be met from family savings or borrowing. The borrowing could be a subsidized loan offer from FAFSA or unsubsidized. Or could be from a private bank. Students who win work study awards are contributing to the Gap amount, but with their sweat rather than with cash.

Our takeaway

Take a minute to study the example graphic above of a college with a sticker price of $75,000 which is the average published cost of attendance at most Ivy League and world-class institutions. Notice how various pricing components kick in above the family's EFC. A $40,000 - $45,000 EFC determination is normal for a U.S. household with two children with both parents working in professional jobs.

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