How Do Scholarships Affect Financial Aid?

“Apply for all the scholarships you can.”

It’s common advice given to high school juniors and seniors. And it’s truly excellent advice.

Scholarships and grants that don’t have to be repaid are basically free money to go to school. Even small scholarships can cut down the cost of books and other essentials. So, they’re nearly always worth some effort.

But how do scholarships affect financial aid?

What many future college students don’t know when they apply for scholarships is that outside scholarships can actually impact federal student aid.

To wrap your head around how this works, you need to start with a basic understanding of financial aid. It’s more complicated than you may think! Once we get that down, we’ll talk more about how those scholarships could impact your financial aid possibilities.

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How Does Financial Aid Work?

You might think of financial aid as being strictly made up of federal student loans and grants. But technically, it can be a package that includes federal loans and grants; state grants and scholarships; school-based, work-study income and scholarships; and outside scholarships from third-party, non-profit or private organizations.

In fact, most students’ financial aid package will be a mixed bag of some, or all, of these funding options.

What many students don’t understand is that financial aid is actually calculated at the school level, not the federal level. Yes, getting your aid package often starts with the Free Application for Federal Student Aid (FAFSA). But individual schools use the numbers from the FAFSA to customize an aid package based on your particular needs.

The financial aid formula is complicated. But it boils down to one main number: the expected family contribution (EFC).

The EFC essentially says how much your family is expected to contribute to your college education. This number stays the same regardless of where you choose to go to school. It’s based on a variety of factors, including your income, your parents’ income (if they still claim you on their taxes), and both your personal and family assets.

The EFC is set up against your school’s total cost of attendance (COA). The difference between these two tells schools how much need-based aid — including Federal Pell Grants, Federal Work-Study Program Income, Direct Subsidized Loans, and Federal Perkins Loans — you can receive.

Other loans, including Direct Unsubsidized Loans, aren’t counted in this need-based aid amount.

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Got all that? It’s confusing, but in essence, it boils down to this equation:

Cost of Attendance – Expected Family Contribution = Need-Based Aid

It’s Calculated on a School Basis

You may already see where this is going. If the formula relies heavily on a school’s COA, the result will vary from school to school.

It’s true! This is why going to a school with a higher sticker price doesn’t always translate into bigger student loans.

If you go to a school that costs $15,000 per year, your need-based aid amount will be lower than if you attend a school that costs $30,000 per year.

Individual schools may also try to draw you to their programs with additional scholarships and grants. Sometimes these are administered based on financial need. Other times, they’re given out based on athletic or academic merit, or by your joining of a particular program or major.

Those scholarships and grants — along with outside grants and scholarships — affect your non-need-based aid amount.

Non-need-based aid can be covered by Federal PLUS Loans, Direct Unsubsidized Loans, and TEACH Grants. The formula for non-need-based aid is:

Cost of Attendance – Financial Aid Awarded So Far (including need-based aid) = Non-need-based Aid Eligibility

The Limits of Federal Aid

How do those scholarships from outside organizations fit into this complicated mix? It depends, actually.

For one thing, you should understand that you can’t receive more need-based aid than your actual financial need. If your COA is $15,000 and your EFC is $10,000, you can’t receive more than $5,000 in need-based aid.

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So, now you’ve got a $5,000 need-based aid offer. This is great, since this type of aid is either subsidized or free. But what if you don’t have $10,000 lying around to pay for your EFC?

This amount can be covered by non-need-based aid. This type of aid is more expensive since it must be repaid and starts accruing interest immediately. This is why school aid packages will start with cheaper (or free!), need-based aid before adding in the non-need-based aid you need.

In our running example, you could get $5,000 of need-based aid, likely spread between Pell Grants and Subsidized Loans, and $10,000 of Direct Unsubsidized Loans.

Because of the non-need-based aid formula, you can’t receive more in this mixture than your school’s cost of attendance. (By the way, this includes basic living costs. That is why some people can literally live on student loans while they’re in school full-time.)

So, since you can’t receive more federal financial aid than your school’s COA, what happens when you add in scholarships, either from your school or from outside sources?

Aid Package Policies

The FAFSA will ask for any scholarship or grant money you’ve already received in the last year. It’s also a good idea to let your school know about additional money received after you’ve filled out your FAFSA.

How scholarships affect financial aid depends on a couple of factors: federal rules and the school’s aid package policy.

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First, the Federal Rules: The federal government sets an annual limit to govern over-award situations. The most recent documentation shows an over-award limit of $300. So, if your total aid package exceeds the cost of attendance by more than $300, the school has to reduce its aid package until it meets this threshold.

If the school’s COA is $15,000, and your total aid package amounts to $15,500 after you add one final scholarship, the school may, for instance, reduce your Direct Student Loan amount by $200-$500.

Next, the School’s Rules: Beyond this, the federal government doesn’t have many set rules for governing aid packages. Schools can decide how they want to meet the over-award limit rule. And they can basically govern their individual aid package rules as they see fit.

The government does offer suggestions, though, and schools tend to follow them.

For instance, need-based aid is first fulfilled by Pell Grants, if possible. These don’t have to be repaid, so they’re more beneficial for students. Then, subsidized loans and work-study programs are added. Again, these are more beneficial for students.

But each school will have a slightly different way of dealing with outside aid in their packaging process.

Here’s a scenario to help you see how it might work:

Your aid package offer consists of a $1,000 Pell Grant, $1,000 in subsidized student loans, a $5,000 scholarship from the school, and a $5,000 unsubsidized federal loan.

You unexpectedly receive a $1,500 scholarship before the semester begins. When you inform the aid office, they could:

  1. Reduce your school scholarship by $1,500. So, you’ll still have the same scholarship and loan amounts for the year.
  2. Add your new scholarship to the package, and reduce your unsubsidized loan offer by $1,500.

Related: The Definitive Guide to Student Loans

Obviously, scenario B is the better option! You’ll graduate with $1,500 fewer dollars in debt — or even more if the scholarship is renewable.

Can A Scholarship Hurt You?

So, the bottom line here is that, in some cases, a scholarship can hurt you. But it’s a very limited harm.

The worst-case scenario is that a school replaces its grants or scholarships with the outside scholarship. You’ll wind up with the same amount of debt you’d have had to start with, but you won’t wind up with more.

It’s basically a break-even, except that you’ll likely have spent time working on the scholarship application.

But that’s the worst-case scenario. In reality, most schools try to give their students the best financial aid package possible. And, of course, that means more grants and scholarships and fewer loans.

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With that said, it’s a good idea to check with your school on their financial aid package policy before you apply for additional scholarships. Count any that you’ve already secured in your FAFSA application. And let your school know about any additional scholarships that come in after you’ve gotten your financial aid offer.

What About Taxable Scholarships?

One item to note: some scholarships may be taxable income. In this case, they can have an effect on your future aid eligibility.

According to the IRS, most scholarships, fellowships, and grants are tax-free, at least in part. They’re tax-free if:

  • You’re currently enrolled in a degree program at a legitimate school, and
  • The money is used to pay for tuition, fees, books, supplies, and equipment required by your school or your courses.

Scholarships are taxable if:

  • Money is used for incidentals like room and board, travel, and optional books or equipment, or
  • The money is received as payment for teaching, research, or other services, except in particular programs.

For more details of these requirements, check here. If your scholarships are partially or fully taxable, you’ll have to count them as income on your tax return. And in this case, the income could affect your EFC two years after you receive the income.

For more on this, check out our comprehensive article on assets and student loans. The federal formula used to count the prior year’s income, but it now counts the prior-prior year’s income in the aid calculation.

Related: The Complete Guide to Saving for College With 529 Plans

You Should Still Apply for Scholarships

Is your head spinning now? What you’re probably wondering is simply whether or not you should apply for scholarships.

The answer to that question is, in short, yes!

Grants and scholarships are still free money that you wouldn’t have had otherwise. And for most of them, the time input can result in a much bigger payout than you’d get from similar hours spent flipping burgers or mowing lawns.

With that said, how schools treat scholarships should factor into your college decision. As we’ve already said, students are often surprised to find that schools with a high sticker price offer better aid packages. As you’re sorting through your school options (which you should only do after you’ve got financial aid offers in hand!), ask about how schools deal with scholarships.

You’ll want to know this if you’re still waiting to hear back from scholarship organizations about outstanding applications. But it’s also important to know how the school might change your future year aid packages if you win a grant or scholarships later in your college career.

How scholarships affect financial aid will vary depending on the school and your current need status. But they’re still usually worth the time and effort to win.

Speaking of winning scholarships, have you entered the Dough Roller Scholarship Contest yet?

 

Topics: Education

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