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The FAFSA And Real Estate: When To Buy And Refi To Get The Most Aid For College

Getting ready to fill out the dreaded Free Application for Federal Student Aid (FAFSA)? It’s the form that strikes fear in parents of college students and college students-to-be who have been cautioned about the tedious process involved, and the disappointing results. And while there is a ton of advice out there about how to properly prepare, what you need, and what to expect, there’s another layer of concern for homeowners and homebuyers: How does the FAFSA affect you if you’re in the market, already own a home, have investment property, or are thinking about refinancing? We’re breaking it down.

First, a little bit about the FAFSA for those who have not yet had the pleasure: “Based primarily on your family’s income and assets, the Expected Family Contribution (EFC) qualifies students for federal grants, loans and work-study programs,” said Bankrate. “The purpose of the FAFSA is to calculate your expected family contribution, or EFC – the amount the government believes your family can contribute for college that year.”

The good news for homeowners getting ready to fill out the FAFSA is that a principal residence is not reported as an asset. But, other real estate holdings may count as assets and may reduce your financial aid award.

Rental income

If you have a small business that is both owned and controlled by your family and has fewer than 100 full-time (or full-time equivalent) employees, it is not a reportable asset. However, income from a rental property cannot be included as a small business.

“Rental properties are a popular tax and investment strategy among parents, but they do not qualify as a family controlled small business asset that can be excluded from the FAFSA,” said Forbes. “Don’t make the mistake of thinking that you can just throw your rental properties in an LLC and exclude the value as a small business on the FAFSA.”

Real estate can be reported as an asset on the FAFSA as either investment real estate or business/farm assets. “For real estate to be considered a business asset, it must be used in the operation of the business, not incidental to it,” said Fastweb. “Sub-regulatory guidance published by the US Department of Education indicates that, ‘A rental property would have to be part of a formally recognized business to be reported as such, and it usually would provide additional services like regular cleaning, linen, or maid service. This is similar to IRS guidance concerning whether rental income from real estate must be reported on Schedule E or Schedule C of IRS Form 1040.'”

If you’re unsure of whether to report rental income as a business asset or investment asset, there are some rules of thumb that you can read about here, but the best course of action is to consult with your accountant or tax attorney. Keep in mind, though, that reporting real estate as a business or farm asset has “less of an impact on the student’s expected family contribution (EFC) than investment assets.”

Shifting assets

Because your principal residence is not a reportable asset on the FAFSA, it doesn’t matter how much equity you have in your home; whether the house is worth a mere $100 more than when you bought it or you have $300,000 worth of equity, it won’t count against you.

Paying down the balance on your home prior to applying for the FAFSA is one of the strategies recommended by financial professionals for those who need to lower their cash on hand and savings. “To get the most financial aid, consider shifting some assets from reportable categories into nonreportable ones before you sit down to fill out your FAFSA,” said TIME Money. “For example, you might use some money from reportable assets like bank accounts and mutual funds to pay down the mortgage on your home, which doesn’t count as an asset on the FAFSA.”

Refinancing

But, home equity can come in handy in another important way: tapping into it can be a smart move if you’re low on funds and need to find a way to pay for college, especially if the interest rate is lower than a federal Parent Plus loan or a private education loan.

Refinancing, and, especially a cash-out refinance, can be especially tempting if you have an interest rate that is higher than what is currently being offered. A cash-out refi would readjust your rate (hopefully to something lower than what you currently have) and give you money that could be used to pay for college tuition. But, there are issues associated with this type of refinance that may make you think twice, like the upfront disbursement.

“This yields a lump sum in advance, years before the money is needed,” said fastweb! “The interest rate may be very low, but the borrower will pay interest on the loan for many years before the money is needed to pay for college bills. Interest begins accruing from the date of disbursement. Another problem with a cash-out refinance is that the money will be counted as a parent asset until it is used, reducing eligibility for need-based financial aid.”

For this reason, a home equity line of credit (HELOC) is often the preferred refinancing method for those looking to use the funds for college.

“In a climate of lower housing interest rates, a home loan might seem like an attractive option for some parents to help shoulder the cost of paying for college,” said US News. “A HELOC is a type of home equity loan that allows borrowers to borrow a line of credit against the value of their home – it operates almost like credit card and usually has a floating interest rate. A borrower can limit the amount to just what’s needed under a HELOC compared with a home equity loan, which requires taking out a lump sum. The minimum amount for a home equity loan can range between $10,000 and $25,000 at lending institutions, home loan experts say.”

Be aware, though, that, a HELOC may be counted toward your EFC. Because of this, the timing of taking out the loan and filling out the FAFSA is critical. Waiting until after you file the FAFSA to take out the loan, or timing it so the proceeds of the HELOC do not hit your bank account until after you file, can protect these funds from being counted against you and having your need-based aid reduced.

Getting ready to buy a house

If you’re in the market and wondering you to manage the timing of your home purchase and FAFSA filing, you’ll be pleased to know that buying now will likely help you when it comes to getting money for college. In determining your need-based aid, any money you currently have set aside for your down payment and closing costs would be used to reduce the amount of aid awarded. Putting it into a home improves your financial picture, at least in terms of the amount of help you can get for college.

The FAFSA has questions that “ask about how much cash students and parents have in savings and checking accounts at the moment you are filling out the FAFSA,” said TIME Money. “But notice that there are no questions on the FAFSA about your debts or bills.” That means that sheltering your money in real estate, so long as that real estate is the only property you own and you intend to live in it, is a smart move.