Financial Aid 101

It's graduation season at high schools and colleges across the country, and for many, that means student loans are on the brain. Most parents of students fall into one of two camps when it comes to loans—either you need them because your child just graduated high school and is looking toward college come fall or it's finally time to start paying them off now that your graduate has her college diploma in hand.

In either case, things can get a bit confusing. Here are my tips for finding the best loans and then setting a repayment strategy when the time comes:

You don't want to be taking out a loan if you can get the money you need through scholarships or grants for free. You may think you make too much money for your student to qualify for financial aid, but there's a good chance you're wrong, so it literally pays to fill out the Free Application for Student Aid (FAFSA) just in case. There's no harm in trying. If it turns out that your finances don't qualify for need-based aid, don't forget to check out money that's given based on merit, says Martha Holler, a spokeswoman at Sallie Mae. The fact is that merit-based aid is one of the fastest-growing components of financial aid, particularly at the state level, and in the last decade, the number or amount of state grants awarded based on merit has increased 250 percent. That means there's a good chance your child can score some free money if she had high grades in high school or participated in extracurricular activities.

If your child's already been accepted, maybe even assigned a room in the dorm, head to the school's financial aid office (and these days, that might mean simply logging on to the website) and check out their preferred lender list. This is a list of private lenders that the school recommends, meaning they've been vetted by the financial aid office, and in most cases, the school has also brokered some kind of arrangement so that there are advantages to choosing these companies. But that doesn't mean you're limited to this list, says FinAid.org's Mark Kantrowitz. It's a good starting point, but use your own judgment and don't rely on it entirely. If you don't like what you see, do a search online and see if you can come up with something better. Just be sure to read the fine print before signing on any dotted lines.

What should you look for in a private lender? All federal loans grant a six-month grace period after graduation before your student has to start paying the loan back, so try to find a private lender that gives some breathing room as well. This is important because you don't know how quickly your child will be able to find a job, and if she doesn't have the income to pay, you don't want her to default and put a black mark on her credit report. Another thing to look for is a company that doesn't charge a fee for prepaying if she does happen to have extra cash during that grace period (this is a great use for those graduation gifts!), you want to be able put it toward the loan without paying a penalty. Anything you can contribute early will lower your total cost of borrowing.

Advice on how much is too much varies. Some people, like Mark, say you shouldn't take out more than your expected starting salary, but that can be hard to estimate, particularly because so many people change majors midway through college or take a job outside of the their field after graduation. At the very least, don't borrow more than the cost of tuition, and less is always better. Remember that this is money that is paid back, and if it's used for things like new shoes or a daily latte, your child is going to regret it later. Encourage your student to keep loans at a minimum and instead get a part-time job or see if she's eligible for work-study to pay for any extras.

The standard repayment time on federal loans is 10 years, but there are a range of options available. If you select a longer time frame, payments will be less each month, but you'll be paying more money in the long run due to interest. For instance, if you switch from a 10-year to a 20-year repayment plan, your monthly bill will be cut by about a third, but you'll more than double the interest paid, Mark says. It's up to your student and her budget, so sit down and figure out the maximum amount you can afford each month. She can always increase it—or even decrease it, if need be—later.