Will Home Equity Hurt Chances for Financial Aid?

Many parents worry that their home’s value will ultimately make their child’s college tab more expensive.

The good news is that home equity is not a factor for the vast majority of private and public colleges and universities.

Related: Four Ways Clients Can Access Their Home Equity

The bad news is that most sought-after private colleges and a tiny number of highly popular state universities do assess home equity.

Let’s first look at institutions that don’t assess home equity. The schools in this category only require families to complete the Free Application for Federal Student Aid (FAFSA), which doesn’t ask about home equity of the primary home. Your clients should not include the equity of their principal home when asked to share the value of their investments. This does happen, which is frustrating since clearer instructions on the FAFSA would go a long way toward eliminating this error.

Related: Kellan Brown on Using Home Equity Within Financial and Retirement Planning

The FAFSA does require that parents include the value of the equity of other properties, including vacation homes.

The institutions that are interested in home equity require filing of the FAFSA and the CSS Profile. Roughly 200 colleges and universities use the Profile because they believe that this more in-depth aid application provides a more accurate snapshot of a family’s ability to pay for college. These institutions use the Profile to determine who qualifies for their own in-house money, and they rely on the FAFSA to determine if the student is qualified for any federal or state aid.

Some parents don’t realize that aiming for popular private schools will require filing the Profile along with the FAFSA. For instance, a friend of mind did not understand that the Profile was also required, and when her daughter was accepted to a highly selective private college in New York, she received no institutional financial aid. With the school unwilling to extend the Profile deadline to the family, the teenager couldn’t attend her first-choice school.

Among the schools that use the Profile are the institutions that enjoy superior U.S. News & World Report rankings. That includes the Ivy League schools, Stanford, MIT, Rice, Northwestern, Amherst, Pomona and Swarthmore. The handful of public universities that use the Profile include the University of Michigan, the University of Virginia and the University of North Carolina. You can find the list of schools that use the Profile on the College Board’s website.

A school’s use of home equity can be financially brutal for families who would otherwise qualify for need-based financial aid. And considering that some highly rejective colleges now are charging $80,000 a year, more people would qualify for need-based assistance than you might imagine.

Home equity is considered a parental asset, which also includes such assets as 529 plans, brokerage accounts, certificates of deposit, and checking and savings accounts. These assets are assessed at up to 5%. So, if a home’s equity is $500,000, the eligibility for financial aid (500,000 x 5%) would drop by $25,000.

Profile schools, however, do not assess home equity the same way, and, because of this, the odds of receiving need-based aid can differ significantly among these institutions.

Here are the three ways that Profile institutions tend to handle home equity:

Schools that assess all home equity.

This is the worst-case scenario. Whatever home equity a family has will be assessed at 5%. The family will self-report the home equity so it behooves them to choose the lowest value. You can find values on websites like Zillow and Redfin or through neighborhood comparables.

Parents should also consider reducing the value by how much it would cost to sell a house, including brokerage fees. Schools that in recent years have assessed the full home equity include New York University, American University, Boston College, Tulane University and the University of Notre Dame.

Schools that ignore home equity.

This is the least popular option among Profile institutions. Schools that recently were not assessing home equity include Stanford, University of Southern California, Harvard, Princeton and the University of Chicago.

Schools that limit a home equity hit.

Some colleges impose a home-equity cap that’s tied to the family’s income when calculating aid eligibility. For instance, a school might assess home equity with a cap at one, two or three times the family’s income. This policy makes it less likely that parents who are house rich but cash strapped will be harshly penalized.

Let’s say the parents make $120,000 a year, but their home equity is valued at $700,000. In this example, the school limits home equity value to two times a household’s income.

Here is how it would work:

$120,000 x 2 = $240,000

In this example, the school would use $240,000 of home equity in the family’s aid calculation instead of $700,000.

240,000 x 5% = $12,000

So, in this instance, the parent’s eligibility for aid would drop by $12,000 rather than $35,000.

Use a Net Price Calculator

One way to determine how a Profile school treats home equity is to use the institution’s net price calculator. Run the calculator using the home equity and then run it again without and see if there is an aid difference.

Parents should also ask individual schools how they assess home equity. It’s best to do this via email, so parents have a record of a school’s response later on if they end up appealing a financial aid award.

Finally, parents need to know that they have the right to appeal a financial aid award for any reason, including the use of home equity.

Lynn O’Shaughnessy, a nationally recognized college expert, offers an online course—Savvy College Planning—exclusively for financial advisors.