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Imagine this: Your recent high-school graduate child runs down the stairs screaming your name. You look up and see their face filled with confusion and anxiety. Nervous, you ask them what's wrong.

They say that they received their college financial aid package. They're unsure what any of it means, and they're looking for mom and dad to answer their questions. Would you know how to explain their aid to them?

This scenario isn't uncommon, as two-thirds of full-time students receive grants and scholarship money, and 34% of those who receive financial aid get some type of federal loan.

Could you explain everything in their financial aid package? If not, here's everything you need to know about financial aid.

Financial aid package 101

Students who need financial aid to attend college must fill out a Free Application for Federal Student Aid (FAFSA) by a given deadline (which can be found online). After students complete the application, each college that accepts them will send them a financial aid package. This package tells them all the assistance they would receive if they attended that college, in addition to how much they (or their parents) would pay out of pocket.

The amount of money that a student receives is calculated by taking two numbers into consideration: expected family contribution (EFC) and cost of attendance (COA). EFC is how much FAFSA expects parents to contribute to college costs given various inputs, including parent income. 

Note that COA varies by school. According to FAFSA's website, some schools only include a student's tuition in the cost of attendance, while others include room and board as well. The same goes for costs like books and supplies, transportation, and personal expenses.

The difference between the cost of attendance and the expected family contribution is a student's demonstrated financial need. Most schools attempt to provide financial aid equal to a student's demonstrated financial need, but sometimes colleges don't have the necessary funds, and there's a gap. 

Show me the money

Once you understand the numbers that go into determining financial aid, it's time to look closer at the money within the package.

There are four types of money that your child can receive: grants, scholarships, work study, and loans.

Grants
Let's start with grants, as they're one of the best items to see on your report. A grant is money to help pay for college that you usually don't need to repay. Yes, that means it's free money. Grants are typically provided based on need, so you're more likely to receive one if you have a low EFC. The Federal Pell Grant is a common grant awarded based on set factors like COA and financial need. Grants can also come from the state government, your college, or a private or nonprofit organization. The money does occasionally need to be paid back -- for instance, when a student drops out halfway through a semester.

Scholarships
Next we have scholarships. Like grants, scholarships do not have to be repaid. Unlike grants, however, they're typically awarded on a merit basis, so the student must demonstrate a particular quality or a degree of skill or hard work. Students can also be awarded for playing a college sport, performing community service, having a minority identity, playing an instrument, or memorizing the lyrics of Lady Gaga's discography. OK, so that last one may not be real, but given the countless scholarships awarded by nonprofits, businesses, and educational institutions, you'd be amazed at what you can find.

Work study
Next, we have work study, which subsidizes students' costs as payment for part-time work. Work study is provided to students who fill out the FAFSA, qualify as financially needy, and attend a participating school. Work can include both on-campus and off-campus jobs, provided the latter relates to academic work.

Student loans
Finally, we have the worst type of aid: loans. These are funds that do need to get paid back.

First, we have federal Stafford Loans -- student loans that come from the federal government. There are two kinds: subsidized and unsubsidized. In either case, your kids don't need to make a payment until six months after they graduate, and both have a 4.29% interest rate.

The loans differ in how the interest accumulates while the student is in school. Subsidized loans are "subsidized" because the federal government pays the accruing interest on these loans until the first payment is due six months after graduation. Unsubsidized loans are "unsubsidized" because interest accumulates during college -- which means the total amount owed after graduation far exceeds the current number on the financial aid package.

If the money from grants, loans, scholarships, and work study doesn't cover a student's cost of attendance, then there's a gap that can be alleviated with two options. Parents can take out PLUS loans up to the amount not covered at a 6.31% interest rate. Alternatively, students can take out private loans from lenders such as Sallie Mae or Wells Fargo that average around 9% to 12%. Both loans accrue interest upon disbursement, but parents can repay PLUS loans six months after graduation, while private loan repayment varies depending on the contract. 

Now that you're a financial aid expert, you're ready to give your child all the information they need. Just pray there aren't too many loans in the package, as this year's graduates with student loans had an average of $37,172 in debt.

 

Michael Schramm has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.