(MONEY Magazine) – At 16, Katherine Haynie put together a car stereo and fell in love with audio engineering. So when she applied to college, she set her sights on the prestigious Massachusetts Institute of Technology. A National Merit Scholarship finalist with combined SAT scores of 1,520, the Davie, Fla. student was an ideal candidate for admission but not for financial aid. MIT bases aid strictly on economic need. The university admitted her but, since her mother and stepfather earned more than $100,000 last year, offered only a $2,625 loan. Katherine's mother, who was paying off hefty debts, could not afford MIT's $34,100-a-year tab.

Enter the University of Miami, which had just created a major in audio engineering. Eager to attract top students, UM showered Katherine with cash, awarding her a whopping $22,700 in grants and loans. Her out-of-pocket cost: just $5,000 a year. For Katherine, the choice was simple. "The University of Miami is too great a deal to pass up," she says, adding, "Maybe I'll think about MIT for graduate school."

Let's face it: Financial aid has become a free-for-all. Shrinking government funding, soaring tuition prices and shifting aid-eligibility formulas have eroded what just 10 years ago was a relatively straightforward process. Today, fewer and fewer colleges grant financial aid purely on the basis of need--and those that do have made the standards too stringent for most middle-class students to qualify.

Meanwhile, colleges with strong endowments are handing out aid based on academic merit or special talents, regardless of need. Indeed, Washington College, a small liberal arts school in Chestertown, Md., knocks $10,000 a year off the tuition of any member of the National Honor Society it admits.

The result, as Katherine Haynie found out, is that you may get little or no aid at one college, while another will let you in for virtually nothing. "The experience was very stressful," says Katherine's mother, Mary Griesemer. "And some colleges were cold and unhelpful."

What brought on this upheaval in the financial aid office? Look first to Washington. Since the early '80s, federal funding, which accounts for 75% of all financial aid, has not kept pace with rising enrollments or inflation. For instance, the Pell Grant for low-income students is worth 25% less today, in inflation-adjusted dollars, than it was in 1978. What's more, back then Pell Grants, which don't have to be repaid, made up 76% of all federal funding for student aid. Today, loans account for 77% of federal aid.

Private colleges have tried to make up the difference by awarding aid from their own coffers. In effect, though, students who pay full tuition subsidize the rest: The doubling of so-called institutional aid in the past 10 years has helped push up college tuition costs an average 7% a year since 1980. That rate is beginning to slow, but last year's 5% price hike is still far ahead of inflation and real wage growth.

But there's good news too. Yes, the big aid squeeze has worsened the pressure on families who aren't rich enough to afford college easily but aren't poor, either: Most families earning $50,000 to $100,000 are deemed too well-off to qualify for much in the way of federal grants or need-based aid. On the other hand, merit aid can help--if you know how to target a school that appreciates what your child has to offer. So your prospects will depend mainly on how well you can play the aid game. Says Brad Barnes, a college aid counselor at College Quest in Denver: "To get your fair share of aid, you will have to fight for as much as you can."

To help you in that fight, we've come up with 10 key questions you should ask yourself and strategies for making the most of the answers. But first, consider these three developments in the financial aid arena:

NEW FLEXIBILITY AT TOP SCHOOLS: A few prestigious schools that still base financial aid on need alone are making it easier for cash-strapped middle-class and upper-middle-class families to qualify. Princeton announced in January that it would no longer count home equity as an asset for most families earning up to $90,000 a year--a move that could increase aid packages to those families by an average $3,000 to $4,000. Princeton will also award grants, rather than loans, to families with incomes below $40,000.

Yale and Stanford have followed with similar home-equity breaks. Harvard hedged its bets, telling students admitted to its freshman class that it would consider matching rival offers. "Princeton's move ups the ante for all top colleges and universities," says Philip Wick, financial aid director at Williams College in Williamstown, Mass. "All of us may have to move in a more realistic direction and award more aid."

Spurred by Princeton's announcement, the College Scholarship Service, the College Board unit that collects data used to determine financial need, is proposing changes to its formula that would cut some families' expected contributions. "There's a growing feeling that our methodology assesses families earning between $50,000 and $100,000 too harshly," says Edwin Below, a former financial aid officer at Wesleyan University in Middletown, Conn. who heads the CSS standards committee. The new rules are likely to be approved for the 2000-2001 academic year.

FATTER DISCOUNTS FROM SECOND-TIER SCHOOLS: "Once you look past the 45 or so highly selective colleges, it's much more of a buyer's market," says Michael McPherson, president of Macalester College in St. Paul and co-author of The Student Aid Game. A 1997 survey of 340 institutions by the National Association of College and University Business Officers found that the average private college or university is giving back 36.7% of its published price as aid to freshmen, an increase of nearly 40% since 1990.

You might think that colleges would lower their sticker prices rather than discount so heavily. But as Arlington, Va. education consultant Arthur Hauptman notes, discounting "enables schools to tailor their financial aid packages to attract the students they want...[and] also maximize their net revenue." What that means in plain English is that colleges want to give away as little as possible--and only those who ask for a discount will get it.

Some 65% of private colleges and 27% of public colleges use this kind of targeted aid, according to USA Group Noel-Levitz, a Littleton, Colo. enrollment-management company. In fact, a growing number of colleges (including Baylor University and Ohio State) actually hire firms like USA Group Noel-Levitz to help them decide how to get the biggest bang from their financial aid dollars. Using software that analyzes such factors as students' demographic background, academic record and intended major, these firms calculate the precise amount of aid to offer each applicant--a process college administrators call financial aid leveraging. "The goal is to take advantage of the family's willingness to pay," says Thomas Williams, president of USA Group Noel-Levitz. "It doesn't make sense to offer $1,500 to meet an average student's full need when you can offer $500 to three students you really want and get them all to come."

NEW HELP FROM THE TAX MAN: The 1997 tax bill gave a few modest goodies to parents saving for, or paying for, their children's higher education. To see which is best for you, see the chart on page 182. Keep in mind that you may take only one of these tax breaks for each student in your family in any given year.

Here are the options: If your children are still young, you can open an Education IRA, which allows you to save as much as $500 a year, tax deferred, for education expenses after high school. One drawback: The money must be saved in the child's name, which may reduce his or her ability to qualify for financial aid later on. If your kids are entering college now, look into the Hope (Helping Outstanding Pupils Educationally) Scholarship, a tax credit of up to $1,500 a year per student for parents of freshmen or sophomores. For juniors or seniors in college, there's the lifetime learning credit, a tax credit of as much as $1,000 a year. Before you check off the box on your next 1040, though, be sure the colleges your child is applying to don't plan to count the credits as income in their 1999-2000 aid formulas.

If your kids are already in college, you can deduct interest on the first 60 payments of their education loans. If your own income is too high, your kids can probably deduct the interest.

With that groundwork laid, let's get into the nitty-gritty of strategy. Here are our 10 questions:

1) HAVE I DONE ALL I CAN TO FIT INTO FINANCIAL AID FORMULAS? If you're truly canny, you'll begin planning for financial aid eligibility before your child learns to drive. Here's why: Many private colleges ask, as part of the aid application, to see your tax return for the year beginning Jan. 1 of your child's junior year of high school. If you can minimize your income or draw down assets before that point by shifting the timing of moves you'd been planning, you can maximize your aid eligibility. Three savvy and legitimate steps: remortgaging your house to fund renovations, which will reduce your home equity and therefore your net worth (this affects eligibility only at private schools); drawing down savings to pay off credit-card balances, which reduces your assets (colleges don't count credit-card debt as a liability); or leaving a job to start your own business. Also, parents who are 59 1/2 or older should minimize any IRA withdrawals, which will be counted as income. Some experts suggest that you try to collect a year-end bonus early or take a loss on an investment (to offset gains on other holdings), but it's probably not worth the bother for aid alone: Those tactics reduce your income for only one year, and you're facing four years of financial aid applications.

Income shifting is more problematic if you're seeking aid from highly selective universities like Cornell and Harvard, which may also ask to see your tax return for the year beginning Jan. 1 of your kid's sophomore year. "That way, colleges can spot discrepancies in income and assets from one year to the next," says Monique Thomas of Collegiate Financial Aid Services in Darien, Conn.

2) HOW MUCH WILL I BE EXPECTED TO PAY? It's essential to get at least a rough idea how your aid application will be rated by colleges. So each year your child is in high school, get both the federal and institutional financial aid formulas (from financial aid guidebooks, college guidance counselors or Internet sites such as www.finaid.org) and calculate your expected family contribution--the amount colleges figure you could afford to pay.

If you stick to public schools, which use so-called federal aid methodology, these estimates should be quite reliable. Private colleges, though, tweak numbers based on their own formulas, which can change from year to year and aren't disclosed. "There are many gray areas, so colleges can interpret the data favorably or unfavorably, depending on how much they want you," says financial aid consultant Kalman A. Chany, the author of Paying for College Without Going Broke. That means one student might get a fatter aid package because the college needs more cellists or kids from the South, while another student might get less because there's an oversupply of premeds.

Even highly selective institutions may engage in bidding wars. "Although Ivy League schools give mainly need-based aid, they still offer preferential packaging," notes David Vonasek of College Planners, financial aid specialists in Belmont, Calif. "They can vary the grant portion for the students they really want."

3) HAS MY CHILD CHOSEN A FINANCIAL "SAFETY SCHOOL"? When college advisers at high schools talk about safety schools, they mean schools that will definitely admit your child. We mean something entirely different: a school your child would be willing to attend, where you're likely to have negotiating leverage. The seven to nine colleges your youngster applies to should include one or two financial safety schools.

How do you identify financial safety schools? First, advises Carol Loewith, an educational consultant in Fairfield, Conn., consider both public and private schools of different sizes in different locations. Second, look for schools where your child's grades and/or SAT or ACT scores will rank "in the top 10% to 25% of the freshman applicant pool," says Michele Hernandez, a former Dartmouth admissions officer and author of A Is for Admission. Then identify the ones with strong endowments and generous per-student aid packages. You can find this information in college guidebooks or the literature provided by the schools.

That strategy worked for Brian Smith of Houston. A student council president and varsity basketball player, he had a 4.16 grade average and combined SAT scores of 1,330. Those numbers were good enough to get the Catholic prep school salutatorian into Princeton, Harvard and Yale, which offered him $3,500 to $8,500 in aid. But he had also applied to the University of Virginia in Charlottesville (average SATs: about 1,300), which rolled out the red carpet with a Jefferson Scholar Award, providing full tuition, room and board, plus an annual $2,500 stipend and a summer study trip to Europe. So long, Ivy League. "UVA has an outstanding program with really exceptional students," says Brian, adding, "I'd like to go to law school at Harvard or Yale, with no debt."

4) WILL B'S GET MY CHILD ENOUGH AID TO GO TO A PRIVATE SCHOOL? Public colleges are not necessarily more generous than private ones to average students. Consider Erica Fine Singer of Easton, Conn. With a B average and combined SAT scores of 980, she thought Ithaca College, a competitive but fairly low-profile private school in Ithaca, N.Y., would be a long shot, despite her extensive extracurricular activities and strong teacher recommendations. Her mother, Lyn Fine McCarthy, a divorced health-care administrator earning $67,000, didn't expect Erica to receive much aid anywhere.

Erica's first choice, the University of Southern Florida, offered only $2,000 to $2,500 in loans. (She didn't apply to the University of Connecticut because it was too close to home.) But Ithaca, which has a relatively generous reputation in financial aid circles, awarded her an aid package worth $12,725, nearly half the total cost. What's more, owing to a reciprocal agreement between Ithaca College and nearby Cornell University, Erica will be able to take classes at Cornell for no extra charge.

5) SHOULD MY CHILD APPLY EARLY DECISION? Not if you really need aid. Yes, the chances of admission are better, since many elite schools now select a third to more than half their freshmen via early decision. But as Morton Schapiro, professor of economics at the University of Southern California and co-author of The Student Aid Game, points out, "These colleges don't want you to apply to lots of other schools, where you might get merit aid offers. And once they have you, they have little incentive to offer the best possible deal on financial aid."

Take the experience of Kenna McKenzie-Young. The Tucumcari, N.M. student, who had a 4.2 grade average and combined SAT scores of 1,380, was accepted early to Swarthmore College, near Philadelphia (total cost: $32,130). Kenna expected to get about $20,000 in aid, since her divorced mother, Marjorie McKenzie, earns less than $50,000 and supports three children. But Swarthmore offered only $4,649 in aid. "We were really disillusioned," says Marjorie.

The problem was Marjorie's interest in a family cattle ranch and farm, which Swarthmore viewed as an asset that she could borrow against. Marjorie argued that the farm belonged to her entire family, including siblings, nieces and nephews, and she wasn't willing to stake it on one child's education. But Swarthmore refused to increase its offer. (When asked about the decision, Swarthmore replied by fax that "schools may differ in their evaluations of a particular family's financial circumstances. We cannot emphasize enough how diligently we work to make the valuation process fair and generous to all our students.")

"Because Kenna applied early decision, she lost any potential negotiating power," contends Alan Posich of Educational Consulting & Tutoring Service in Albuquerque, who helped the McKenzies appeal. After Swarthmore allowed Kenna to apply elsewhere, she was accepted by Grinnell College, near Des Moines, which gave her $15,820 in aid, including $7,600 in grants and scholarships. Says Kenna: "It worked out for the best."

6) AM I EXPLAINING MY FINANCES CLEARLY? The McKenzies' experience illustrates a common pitfall: If your finances are complicated, you risk losing aid. Financial aid officers sift through hundreds of applications in a few weeks. Your child's folder may get just 20 minutes of the administrator's attention, which may not be enough to get a handle on unexpected medical bills, support of an older relative or income that varies from year to year.

To prevent misunderstandings, write a brief letter to the college financial aid officer, giving the pertinent facts and attaching documentation if necessary. "Keep it short," urges College Board's Edwin Below, "and explain exactly how the problem affects your ability to pay."

One frequent error is overestimating the value of your home, especially in hot real estate markets like Silicon Valley or New York City. Private colleges use complex proprietary formulas to calculate the value of your home; the resulting number could well be lower than its current market value. The difference between the college's number and your mortgage is considered your equity, which schools will expect you to tap for tuition payments. So be conservative in assessing your home--but don't go overboard. Aid officers see enough applications to recognize a phony evaluation.

7) SHOULD I HIRE HELP? If you think a lot of money could be at stake, you may want to consult an independent financial aid counselor; the cost ranges, on average, from $100 to $500. (Admissions counselors, who advise on where to apply as well as on aid, charge $1,000 to $2,000.) That's what Mitchell and Shelley Cohen of Holliston, Mass. did when their daughter Heather was accepted to George Washington University in Washington, D.C. in 1997. The Cohens, both schoolteachers, wanted to do the best possible job before committing to spend more than $120,000. "I hire someone to do my taxes," Mitchell says. "I wouldn't try to fill out aid forms myself."

Stuart Farmelant of Student Aid Advisors in nearby Newton, Mass. submitted Heather's aid forms and then appealed when GWU offered only a $2,625 loan. The university assumed that the Cohens could borrow on their home, but it had lost value since they bought it at the height of the '80s real estate boom, making a home-equity loan impossible. After the Cohens backed up their claim with an independent appraisal, the school awarded Heather a $4,000 grant.

This year, the Cohens' net worth went up, and GWU cut Heather's grant to $800, while raising her loan to $3,500. Farmelant wrote an appeal, explaining that Mitchell and Shelley Cohen had covered some of his parents' medical expenses, installed his mother in a nursing home and his father in an assisted-living community and traveled to Florida once a month to care for them. GWU raised Heather's grant to $3,000.

8) DO I FACE SPECIAL PROBLEMS AS A DIVORCED PARENT? In the past, public schools and many private ones asked for financial information only from custodial parents. Lately, both public and private colleges have become much stricter about requiring noncustodial parents to complete a form stating how much they're able to pay for college. Students with absent or uncooperative parents must be prepared to supply plenty of documentation, including notarized statements, past tax returns or copies of divorce agreements, to substantiate a lack of support. "Most colleges are pretty understanding," says Jayme Stewart, a college counselor at York Prep in New York City. "But in the cases of deadbeat parents, or where the situation is tough to prove, the aid you get may depend on how much the college wants you."

9) IS THE AID OFFER CLEAR AND COMPLETE? Once you've been notified of an award, get out your calculator. "Aid letters can be vague and misleading," says Macalester president Michael McPherson. "The letter may tell you that the school is giving a certain amount but leave it up to you to calculate how much more you must actually pay. Or you may not be told whether the aid offer is renewable and under what circumstances." Ask questions and try to get written guarantees so you're not caught short later.

That's what happened to Matt Bahar at Loyola University in Chicago. His parents, Gerry and Sue Bahar of Antigo, Wis., expected their out-of-pocket cost of $4,000 a year to drop to $2,000 for Matt's sophomore year since they'd also be paying college bills for their daughter Becky, now a freshman at St. Scholastica in Duluth, Minn. So they were startled when the cost for Matt's second year remained $4,000, because Loyola had raised its tuition and housing fees. When the Bahars appealed, the university offered a $2,000 low-interest loan. "It was disappointing and confusing," Sue says, though she was pleased with Loyola's responsiveness.

10) HOW CAN I GET A SCHOOL TO RAISE ITS AID OFFER? As the Bahars' example shows, there's no harm in asking for more aid. Financial aid officers, who generally earn less than $40,000 a year, will not be impressed by the burden of mortgage payments on your vacation home in Southampton or Vail, but a sensible, well-crafted appeal that explains why your circumstances require more aid--especially if bolstered by an offer from another school--may boost your package. At Williams College, for instance, 20% of the 600 aid applicants last year appealed the initial offers, according to financial aid director Wick; scholarships and loans were increased in about two-thirds of those cases an average of 20%, or $3,000. Less prestigious schools may be willing to up the ante even more.

Your best strategy is to be clear, courteous and ready to send any necessary documents by fax or overnight mail. Remember too that you aren't playing Powerball. Most colleges are far from wealthy. And any money you get will mean that much less for another bright, deserving student. "It's not a God-given right that your child should go to a costly college," notes Jayme Stewart of York Prep. Still, with the right planning, there's no reason why your child's education should bankrupt you. Leave that to a really expensive graduate school.