Getting started: What is financial aid?

@Money

Financial aid helps millions of students afford college each year.

The money is donated by the government (thanks to taxpayers), colleges and charities and given to students or their parents to help them pay for a higher education.

However, while some types of financial aid are wonderful, other types don't really provide much "aid" at all. That's because there is no truth-in-labeling law that requires colleges, governments or charities to explain exactly what strings might be attached, or how much aid they are really providing.

Grants or scholarships

Here are the three major types of financial aid and what you need to know.

Generally speaking, grants and scholarships offer free money to help you pay for your education. In a nutshell, this can be the best type of financial aid.

The federal government, for example, gave about 8 million low-income undergraduates (from families earning less than about $40,000) Pell Grants averaging about $4,000 apiece in 2010-11 -- that's free money for college that they didn't have to pay back.

But students who receive grants for college need to read the fine print first. Some so-called "grants" are really loans they might have to repay.

Financial aid loans

The federal government's "Teach Grant," for example, provides up to $4,000 a year to fund coursework for students preparing to be teachers in high-need areas. But if recipients of this grant fail to meet the exact letter of the law after they graduate, the grants turn into loans that must be repaid with interest.

Unlike most grants and scholarships, you have to pay these loans back, plus interest.

The biggest source of college financial aid loans is the federal government. In 2011, the U.S. Department of Education loaned more than $100 billion to students and parents.

The lowest-cost federally backed student loan is the Perkins Loan. As of early 2012, this loan charged no interest while the student was in school and only 5% a year after the student left school. Unfortunately, there is a shortage of Perkins funds, so only the neediest students are generally able to take them out.

The next-best deal is the federal Stafford loan. Any student who attends college at least half-time, and is a citizen or has a green card, is entitled to borrow at least $5,500 through this program.

How much will my dream school really cost?

For new loans awarded in the fall of 2012, the federal government was planning to charge 6.8% in annual interest, plus 1 percentage point in fees, for an annual percentage rate of 7%. However, in early 2012, there was some Congressional debate about lowering the rate for students who qualified as "needy."

(Note: Some Stafford loans are called "unsubsidized," but that is a little misleading. Since private lenders won't give most students money at a 7% rate, all Stafford loans are subsidized by taxpayers. The "subsidized" Stafford loans, however, have lower interest costs and so are more subsidized.)

Although that rate may seem high, those student loans are considered "financial aid" because they offer advantages that no private loan does, such as providing loans to students who have no credit history without requiring an adult or parent to promise to repay; giving borrowers the option to make payments based on their income after graduation; and forgiving some of the loan for public service.

Families who need to borrow more than the maximum Perkins and Stafford can try for a federal parent loans, known as "PLUS."

PLUS loans charge 7.9% in annual interest, plus 4% in up-front fees for a total APR of 8.8%. These are considered financial aid because they are available to parents whose less-than-perfect credit scores might be rejected by banks.

Some colleges and charities also offer college financial aid loans that charge no or very low interest rates.

But students and parents need to read the fine print on their college financial aid letters and bills. Not all educational loans are "financial aid." Some are simply standard business transactions. To qualify as "financial aid," student or parent loans are supposed to offer better terms than you could get from a private company such as a bank, credit union or other lender.

Work-Study

Any student can apply for a job opening on- or off-campus to earn money for school. But students whom the college determines have "financial need" have first dibs on certain federally-subsidized campus jobs.

These jobs pay standard hourly wages just like other jobs. But they have one big advantage: Their earnings don't count as income in future financial aid applications, and don't reduce the odds of getting need-based financial aid the following year.

NEXT: Grants and scholarships: How to get free money To top of page

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