Many schools complain that their financial aid systems often reward families for poor choices—such as expensive cars, clothing, and houses. This is most often a symptom of misunderstanding how your formula works. The first thing you must have is a full understanding of the formula that is used, and make sure you agree with its methodology. It is hard to defend an award (or lack of one) without knowing how the decision was ascertained.

If you use an outside vendor, ask for the formula the vendor uses. This is what your school uses to award families and determines where your financial aid budget is spent, so it's crucial that you understand how it works. If you use a formula devised by your school, you should know who devised it and the theory behind the formula. Just understanding the formula helps you to better understand how the award you present a family was determined. This also facilitates the appeals process when a circumstance that may not have been covered in the formula is presented.

After you have obtained and understand the formula being used, decide if you agree with the rationale and how it works. Does the formula allow for "reasonable" expenses? Does it use what the family reports, or a fixed number? ISM feels that a mixture of school-determined and family-reported numbers is most appropriate.

Living Allowance

The family living allowance is an average of expected household expenses for "choice items" such as clothing, transportation, entertainment, and personal effects for two adults over a one-year period. Typically, these are close to impossible for a family to track, and even more impossible to verify. Even if a family is able to track how much is actually spent, there would still need to be a process to determine how much is appropriate. There should, however, be an adjustment for each child—the cost for raising a family with four children is much greater than a family with one child. With the local economies across the country greatly differing, this number should be adjusted for the cost of living in your area. No single number can work for different-sized families or for different areas of the country. Once you trust the number that you determine for your living allowance (an allowable amount for yearly everyday living expenses), you can stop worrying about what kind of clothes the family wears. Everyone is simply credited with a "reasonable" number.

Housing, Insurance, Utilities, and Tax Expenses

For expenses such as housing, insurances, utilities, and taxes, an amount reported by the family serves the school better. These numbers can vary greatly from situation to situation, so using a fixed number (or fixed percentage of income) can misrepresent a family's situation—but more often tends to actually cheat the school. Using a real number for these expenses, however, often leads to financial aid professionals being frustrated by widely varying amounts. The notion that we are rewarding a family that spends more is brought up again and again. The solution is two steps, with the first step being to set a "reasonable" cap. An example might be that a school permits a family to spend up to $30,000 a year on housing costs. This can be highly subjective and may vary from school to school in the same town, depending on differing values and missions.

Once you have decided on reasonable caps, you are ready for the second step of understanding the power of reasonable. Since you have determined a reasonable top end, any number reported below it should be fine and any number above simply gets defaulted to your reasonable number. You will not be considering anything above a number that you would allow, so all families are held to the same standard.

Schools typically make the mistake of thinking "Why shouldn't the families that are more frugal simply get credit for what's reasonable, so that we can treat everyone the same?" This thinking does a major disservice to the school as expenses like housing, insurances, utilities, and taxes can vary greatly from family to family, simply through chance situation and not frugality. Families that rent often don't pay for utilities; families with more children typically pay less in taxes; and families that have a teenager are most likely paying much higher auto insurance. These circumstances have nothing to do with how frugal a family is. Housing is often misconstrued as an indicator of how frugal a family is with their money, but this is not often the case.

Let's look at three common scenarios.

• Family One: Bought a house 12 years ago and now has a mortgage that is well below the market average for your area.
• Family Two: Inherited a house and pay only homeowners insurance and property tax.
• Family Three: Moved into town three years ago and bought a house that cost 30% of their earnings, which is the standard that a mortgage company would approve.

These three families will all be paying vastly different amounts for their housing. Sometimes the difference will be much more than your tuition. The question remains: Is this frugality or merely circumstance? Once you set your housing threshold for what is reasonable—say 30% of earnings—you no longer need to be concerned. You will only consider whatever they spend on housing up to your "reasonable" threshold.

These thresholds should be determined separately for housing, utilities, insurances, and charitable contributions (if this is mission-appropriate). Taxes and Social Security should use the actual number that the family pays in taxes, but probably doesn't need any sort of cap.

Long-Term Saving

If your school feels strongly that families should be putting away money for the future (e.g., retirement, college, rainy day), an allowance for savings can be added to your formula. The school can then ascertain the amount a family is permitted to "save" before the obligation to pay tuition. Some schools may simply decide that a family must save after the tuition has been paid. Remember that this number can only truly work if you are considering a family's gross wages. Many times, retirement savings are taken directly out of pay, which would mean that you would be giving additional credit on top of what the family had already put away.

Understanding the formula your school is using to determine awards—and then setting reasonable thresholds—is the key to feeling comfortable about the awards that you offer your families. The formula may not always be correct, but you will be in a much better position to defend or adjust the award accordingly.