How Does Real Estate Impact College Planning?Financial Planning
BY CYNTHIA MEYER CFA®, CFP®, CHFC®
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What you'll get from this article:
🏠 HOW CSS (COLLEGE SCHOLARSHIP SERVICE) PROFILE AND FAFSA (FREE APPLICATION FOR STUDENT AID) treat REAL ESTATE INVESTMENTS
🏠 what to do if the school overvalues your home or investment property
🏠 BUYING PROPERTY while applying for financial aid
🏠 house hacking opportunities for students
🏠 THE PROS & CONS OF SAVING FOR COLLEGE WITH REAL ESTATE INVESTING
How do real estate investments impact college planning and financial aid applications? I’ve been thinking about this question a lot lately, as my high school senior navigates the college application process. I reached out to my friend Rynda Wilk, CFP®, MBA, a college planning expert with 21Finance, for a discussion of college financial strategies for real estate investors.
What is the Real Estate Impact on FAFSA?
Each year, about 18,000,000 families file a Free Application For Federal Student Aid (FAFSA) form in hopes of qualifying for college aid. The FAFSA is used to determine qualification for federal financial aid by computing your Expected Family Contribution (EFC). About 400 colleges and universities also use the CSS Profile to make need-based aid decisions.
“These forms look at different types of real estate ownership in different ways,” explained Rynda. “It’s important to know how your real estate assets may affect how much you or your child pays for college so you can plan ahead.”
FAFSA - Your family home is not considered an asset for purposes of the FAFSA and EFC calculation, so you don’t include its value when you are filling out your FAFSA form. “However, any other properties your family owns are considered investment assets, including second homes and vacation homes,” she added.
CSS - The CSS does collect information about your primary residence. Each individual school chooses whether or not to factor this information into their aid decisions. Check with the school to find out more.
Action Step: Do you have a highly appreciated home, or have you worked hard to pay off your mortgage? Your Expected Family Contribution is likely to be lower on the FAFSA than the CSS profile. Rynda encourages parents who are concerned about having to report home equity to find out if the schools you’ll consider require the CSS Profile by checking this list.
Investment Real Estate
“Whether you’re investing in real estate as a college student or the parent of a dependent college student, the total net worth (equity) of all investment real estate holdings is factored into both your EFC calculation and the CSS profile,” explained Rynda.
To calculate your real estate’s net worth, subtract any debt owed on the property from its fair market value. “Even if you owe more than a property is worth, this number can not be less than $0,” advised Rynda.
“Up to 5.64% of parental assets and 20% of student assets are included in the EFC calculation,” she cautioned, “so for dependent students it is generally preferable to hold all real estate investments in the name of a parent.”
Action Step - Calculate the net worth (equity) of your real estate investments to find out how much they may affect your FAFSA application and CSS Profile.
An Overvalued Home or Investment Property: What To Do
The CSS Profile asks for your home's value from sites like Zillow or Redfin. Because those sites aren’t always accurate, their estimate may show an inflated value for your home. In that case, Rynda suggests three options for using a different methodology to come up with an estimate:
Option 1 - If you have refinanced your mortgage over the past year, use the appraisal from that process.
Option 2 - Get comps from the MLS showing similar properties recently sold in your neighborhood or similar surrounding neighborhoods. Calculate the sales price per square foot and multiply that by the number of square feet in your home. You can ask a real estate agent for help accessing the MLS or find the data online.
Option 3 - Find out from your property tax assessor what methodology is used to determine the appraised value of your property. For example, some counties will appraise homes at a certain percentage of their value. So, if your home is appraised at $300,000 and the assessor’s office tells you that they report assessed value at 50%, then that would indicate your home would have been valued at $600,000 at the time of the assessment.
If your property tax assessment hasn’t been updated recently or your county uses a completely different methodology, you may not be able to use this option.
“Make sure to document your methodology and be ready to support it should you be questioned,” reminded Rynda.
The school you are applying to may still use a different method to calculate the value of your home. ”Try contacting the financial aid office and asking for a lower value or different calculation to be used,” she suggested. “Be ready to support your request. You may or may not be successful, but it is better to ask - just in case!”
Action Step - Check Zillow, Trulia, Realtor.com, and Redfin to see how they have your house valued. You may see a range of values for the same property on the different sites. Do you agree? If not - start planning your strategy for a different valuation now.
How Rental Income is Reported on FAFSA
Your AGI, or adjusted gross income, will be used to calculate your income for the FAFSA. You’ll find this number on the first page of Form 1040 (line 11 from 2020 return). This number includes your rental real estate income from Schedule E of your tax return, which is then reported on Schedule 1 and the 1040. The amount reported has been adjusted for expenses and depreciation before it makes it to your 1040, so it likely won’t be the entire rental income amount. You can easily get your AGI by using the IRS DRT (Data Retrieval Tool) to import it into the FAFSA.
How to Value Your Rental Property for FAFSA
“You should not have to pay for an appraisal to obtain a value for your property,” assured Rynda. Use a recent appraisal during a mortgage application (Option 1), compare the results of using sites like Zillow.com, Realtor.com, Trulia, or Redfin to obtain a value, get MLS comps (Option 2) or use your property assessor’s site (Option 3). “It is in your best interest to come up with a value that you can honestly substantiate but one that is also as low as possible,” she added.
How does FAFSA verify assets? “Colleges are required to look for discrepancies in your application and may ask for additional documentation if anything seems unusual,” Rynda explained. “They are also required to report suspected misrepresentations to the Department of Education.”
Buying a Property Around FAFSA Time
Buying a rental property will affect financial aid, but it may not make a huge impact. “Actually, because you incur some closing costs to purchase a property, like taxes and fees, your EFC may end up being lower.” said Rynda.
She gave an example: “Before purchasing the property, let’s say you have $50,000 in savings you plan to use for the purchase. After purchasing the property, you have a property worth $200,000 and a loan for $160,000. The net investment value is $40,000 and $10,000 went toward taxes and fees on the sale. From the FAFSA standpoint, you have $10,000 less in reportable assets after the property purchase.”
Rynda added another example: “If you buy a first home - or a more expensive home - to live in during the financial aid application process, your EFC may be a good bit lower. This is assuming that you use considerable cash resources to make a down payment on the home. Your cash savings will be lower and the equity in the home is not counted for the EFC calculation.” However, she added, “If you are funding the entire purchase from sales proceeds from a prior home instead of savings in the bank (in essence, just trading one home for another), there will likely be no effect on the FAFSA.”
If you are also going to be completing the CSS Profile, things are a little different. You will need to think about both your cash on hand before and after a potential home purchase and the net worth of the home (home equity) no matter whether you are buying a main home, vacation home or investment property. “Remember that colleges and universities use this information however they deem appropriate,” counseled Rynda, “So reach out to the individual institution to find out more.”
Action Step - Run a few what-if scenarios to see how a home purchase will impact your FAFSA and CSS Profile.
Buying Real Estate to Get In-State Tuition
I asked Rynda if it makes sense to invest in a rental or vacation property near your child’s target college. “It is very likely that buying real estate alone will not be enough to qualify for in-state tuition,” she explained. If your child is your dependent and goes to high school in your home state, it is very unlikely that they would receive in-state tuition in another state.
“Each state can make their own rules around how to qualify for in-state tuition, so be sure to check with the state you’re interested in,” she added. “Check for schools that offer in-state tuition to students of certain other states - like border states - and schools that offer in-state tuition to students meeting certain requirements - like SAT or ACT scores. Additionally, check for regional reciprocity agreements.
How Do You Establish Residency?
Each state is different when it comes to rules for establishing residency for in-state tuition purposes, however, they will likely be looking for you to have been physically present in the state for a period of time (12 months is common) and show intent to remain in that state after graduating. Also, unless the family is moving together to the new state, the student will likely need to prove independence. Some factors that may help a case for in-state residency are:
- Maintaining a physical address
- Getting a driver’s license and registering a car
- Holding a job locally
- Registering to vote
- Paying income taxes
Keep in mind that there are costs associated with moving to a new state, not to mention the opportunity cost of finishing college a year later and, thus, postponing commencement of a career for another year. You’ll want to think carefully about whether it makes sense to go out of your way to try and establish residency to attend a particular university.
Here are some examples of residency requirements:
Action Step - Look up the state you are interested in, find out what they require to establish residency, or check for border-state agreements.
Do-it-yourself student housing
Purchasing real estate for your child to live in during college is an opportunity to both save money for college and take advantage of potential growth in the real estate market.
“The cost of room and board can be a substantial percentage of the overall cost of higher education,” noted Rynda. Per EducationData.org, “At 4-year institutions, the cost of room and board ranges from $10,216 to $11,945.”
For many students, on-campus housing is not available. According to FinancesOnline.com, “Only 22% of university students in the US live in on-campus dormitories. 55% of US university students live in other types of rental housing, while the remaining 23% live in purpose-built, off-campus housing. (National Real Estate Investor, 2018) Also, they state, “The country’s 175 largest universities can provide on-campus accommodations for only 21.5% of undergraduates. (CBRE, 2019) And, Around 8.6 million students need rental housing near campus. (NMHC, 2020)”
“If you plan for your child to live off-campus, you may want to consider purchasing real estate to provide a home for your child to live in during college instead of renting,’ suggested Rynda. The home could:
- Provide housing to your child during school, possibly at a lower monthly cost
- Continue as a rental property after your child has graduated
- Be sold for after graduation
- Generate rental income offering rooms for rent to other students
For this strategy to be viable, you need to plan ahead to make sure you have the cash needed to pay a down payment and closing costs, savings to cover months when no rent is received, and repairs and maintenance costs. Not all colleges allow students to live off-campus, Rynda reminded, so you’ll want to check on that as well.
Make sure to do a comparison of the cost of buying/owning a property to the cost of paying for room and board. In some cases, it may not be worth the extra effort and risk involved.
Set Your Child Up With Their First House Hack
Another related strategy is to have your child purchase the real estate by gifting them the funds. Setting your student up as a homeowner will help them establish a strong credit score. If they have roommates, they are gaining valuable experience as a landlord and real estate investor. “In some states, a home of their own may allow your child to qualify for in-state public university tuition for their junior/senior years,” noted Rynda.
Keep in mind that gifts of more than $15,000 ($30,000 per married couple) to your child in a calendar year will require you to file a gift tax return (but probably not require you to pay any actual gift taxes).
This strategy could be a fit for parents who:
- Have liquid assets to purchase a home
- Have other family members, such as grandparents, who are willing to gift
However, Rynda reminded that this could be a disadvantage for schools that require the CSS Profile as your child would have to include equity in the home as an asset.
If you’re curious about house hacking with roommates, get the Real Life Planning Guide to Househacking 2.0.
Action Step - Compare the cost of on-campus housing to the net cost of buying and renting out a home to your child and other students.
Saving for College with Real Estate Investing
Like many other types of investing, an investment property may be part of your college savings plan. Think carefully about the pros and cons and make sure you’re financially ready to buy a rental property.
Great Reasons to Pay for College with Real Estate Investing
- Rental income
- Possible appreciation and increase in equity
- May be less volatile than the stock market
- Hedge against inflation
- Possibility of borrowing against property equity to pay college expenses with an equity line of credit or cash-out refinance
Rynda reminds people to also keep in mind the risks of real estate investing for college:
- There may be capital gains taxes if the property is sold at a profit, and depreciation recapture.
- Real estate is an illiquid investment and may not be easy to sell when you need the money.
- It takes a lot more time, effort, and money to keep up a rental property than it does to hold many other types of investments.
- There are no guarantees that a real estate investment will appreciate by the time your child attends a school
Your real estate holdings are an important factor to consider when shopping for colleges and estimating your out-of-pocket expenses to attend a specific college. By planning ahead, you may be able to use real estate to your advantage when applying for financial aid or lowering the cost of room and board.