Watch Out for FAFSA

Every year at this time, students and parents gather to hear advice from experts about filling out the Free Application for Federal Student Aid (FAFSA)—the first step to receiving Pell grants and federal student loans. In North Carolina, for example, this Saturday, February 18, 2012, is “FAFSA Day,” sponsored by three state organizations including the College Foundation of North Carolina.

You may think that FAFSA is just a bureaucratic nightmare (10 pages of complicated tax and income questions), but FAFSA also provides critical information that allows universities to manipulate prices and attract “desirable” students. Thanks in part to FAFSA, the college knows a lot more about what you can pay for college than you know about how much its officials are willing to negotiate—or even what they are looking for.

Just like airlines, colleges and universities engage in price discrimination. That is, they offer different prices to different people, discounting tuition in the form of “merit” scholarships. Two students sitting next to each other in a classroom may have paid vastly different sums for the same education. In the case of the airlines, paying a higher price gets you something extra—the freedom to change your mind and a preferred seat, for example. And you know what you are getting.

But colleges use the FAFSA form, and especially the family’s “expected financial contribution” (EFC, determined by a federal formula) to make their price discrimination as efficient for them as possible. Admissions officials use that information to zero in on the amount of financial aid that is likely to draw the candidates they want to the school. There’s no “wasting” money by giving a family a break on tuition that is any bigger than absolutely necessary.

In a study on price discrimination in college tuition at one private university, Robert A. Lawson and Ann Zerkle identified student characteristics that make universities likely to offer aid. They found that demonstrated need (based on the EFC), high ACT scores, and high school GPA are good predictors of whether schools will offer students institutional aid.

But if attractive candidates—with high ACT scores and high GPAs—are in the middle class and can, even with a stretch, pay the tuition, the likelihood of getting an aid offer isn’t very good. So, even though these discounts on tuition are sometimes called merit scholarships, merit may be less important than the ability of the family to pay the tuition.

For example, imagine a middle-class high school senior with decent grades, a few AP credits, and an ACT (or SAT) score in the 85th percentile. After applying to a few schools around the state, he fills out the FAFSA application to access federal student loans. On the form, he indicates the schools to which he’s applied. This information goes to those schools.

If the student is accepted to an expensive private school, like Campbell or Davidson, (and possesses the qualities the university finds desirable) he’s likely to be offered some form of institutional aid because the universities know that without aid, tuition might be prohibitively expensive.

However, if he is accepted at an affordable state school, such as Appalachian State or UNC-Chapel Hill, the schools will be less likely to offer aid—or will offer less generous aid—because they know the student’s family can afford in-state tuition.

In either case, the universities know just how much the student can pay, while he doesn’t know what the universities want.

George Waldner of York University puts it this way, “[Universities] want [parents] to consider a school with a $45,000 price tag . . . and hope that the financial aid office will be generous enough to cut the price in half. This creates heartbreak for students and unnecessary financial strain on families when the price doesn’t come down enough for those not in favored categories.”

Lawson and Zerkle’s analysis suggests what some of those categories might be. They show that at one university, institutional aid is used disproportionately to attract students with specific characteristics such as race, religion, or out-of-state status. Their analysis shows that a non-white student will receive $2,240 dollars more on average than a white student.

They also find that schools give larger awards to out-of-state students (they speculate that it is because these students are athletes) and to students whose religious affiliations are different from those of the institution. (They speculate that the schools are more confident that applicants with the same religious affiliation will attend, whether they get money or not.) Lawson and Zerkle also show that the university they studied rewarded financial need more than high school performance or test scores. Some critics call this practice a “wealth redistribution scheme.”

Rich Vedder points out in 25 Ways to Reduce the Cost of College that the confusion caused by price discrimination may actually hurt the schools themselves. Since students don’t know their likely institutional aid when they apply, they rely on sticker prices when making decisions about where to apply and attend. The difference between sticker prices and actual prices causes student uncertainty and may lead to “inappropriate student choices,” he says.

This financial aid game seems to yield little benefit for anyone—and can be costly for students.