What is Debt?

2010
08.23

Now that you are ready to fill out the major educational financial aid form or the FAFSA (Free Application for Federal Student Aid), you must recognize the difference between good debt and bad debt.  Basically, it’s imperative to know what is debt in the eyes of the financial aid officer and how to turn your debt to your advantage.

Just like in real life, there is good debt and there is bad debt.  These two shall never meet.  So it’s best to start off with what is bad debt and how to eliminate or vastly decrease bad debt for the base year.


Examples of Bad Debt:

  • Student loans of parents (i.e. Stafford loans, etc.)
  • Personal loans (including car loans)
  • Unsecured loans
  • Unpaid credit card bill(s)

These debts are terrible because they simply do not qualify as debt on the FAFSA.  (Please note: The CSS Profile is different.  It does take into account some of the above listed debt.  To see which debt qualifies, please read CSS Profile.)  To the federal government and financial aid officers at colleges, the above listed debt is not part of the formula to evaluate each student’s financial aid.

Parents should make a conscious effort to pay off any of this debt, or if possible transfer any of their bad debt into good debt (as listed below).  For example, for those parents who have massive credit card debt, it is time to start chipping away at the amount.  Start this process leading into and during the base year to lower your overall income dramatically.  For instance, if both parents make a combined income of $200,000 a year, and they’ve amassed credit card debt in the amount of $20,000, it’s time to start paying off monthly installments to eliminate this debt.  Doing so will lower the overall amount in the parents’ checking account, and subsequently, lower the overall numbers of disposable income on the FAFSA.  Remember, the poorer you look, the better chance of receiving more student college financial aid.

Now let’s discuss good debt.

Examples of Good Debt:

  • First and second mortgages (varies by college)
  • Home equity loans
  • Margin loans (secured loans from a broker)
  • Passbook loans (secured loans by funds from savings accounts)

This debt is good because the financial aid formula takes into account these debts.  Thus, here is a good opportunity to lower your disposable income on paper.  If you can transfer any of the bad debt into good debt, go ahead and do so before the base year.  Once the base year starts, you are set with good debt.

Now that you know what is debt, make sure to follow the above steps to ensure your debt is good.  And always check with a highly reputable financial advisor and/or CPA before making any major financial decisions.  Please check with each college’s financial aid formula to double-check what is good debt.


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© White Picket College, 2010 – College Funding for the Upper Middle Class

4 Responses to “What is Debt?”

  1. Jeff S says:
    August 23, 2010 at 2:04 pm

    This is great advice! Most families have no idea about the differences in types of debt and how to best optimize their finances for the FAFSA. With the new school year starting, it’s a perfect time to start looking at finances for the new FAFSA in January. Keep up the great posts!

  2. admin says:
    August 25, 2010 at 12:02 am

    Thanks Jeff!

  3. Maria says:
    March 26, 2011 at 12:13 am

    Is a Home Equity Line of Credit a Good or Bad debt? Thanks

  4. admin says:
    March 27, 2011 at 5:55 pm

    Hi Maria,

    Thanks for commenting. This is quite a tricky question.

    According to Suze Orman’s Action Plan, Orman says “I have never liked it when families increase their housing debt to pay for school. It typically leaves parents severely in debt just at the point when they should be focusing on paying off their mortgage debt, not increasing it, to prepare for retirement” (page 160). She is referring to HELOC (Home Equity Line of Credit).

    We agree with Orman. If you keep taking out lines of credit on your house, when will you ever own the house? Though HELOC is a fancy name, it is simply a second mortgage. It is best to check with a highly reputable financial advisor and/or CPA, since taking out a HELOC is individual to each person’s financial circumstance.

    However, as stated in the above article, first and second mortgages can be good debt in the eyes of the financial aid formula. So, our advice would be to check with the colleges the student is applying to and then decide from there. Also, how far are you from retirement? That will make a difference in your final decision.

    As for a simple answer to your question: HELOC can be good or bad debt, depending on the situation.

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