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The best money is free money, especially when it comes to paying for a college education. And the biggest sources of free money these days are federal and state grants.

While scholarships make up less than 2% of student aid, grants make up about 40%, with loans filling in the rest.

Grants are a much better deal than loans, of course, because you don't have to pay the money back.

Grant money, however, is usually based largely on need and is often parceled out on a first-come, first-served basis. As college costs skyrocket, it's important to apply early for financial aid and be aware of any available grants that might help lower your college costs.

Four types of grants

First, the major types of grants:

  • Federal Pell Grants. By far the largest grant program, Pell grants range from a few hundred dollars to several thousand dollars. These grants are based solely on need, as determined by the student's college of choice using federally approved guidelines. Eligible colleges receive a fixed amount of Pell money each year; once it's gone, it's gone, which is why it can pay to apply for aid early. Students receiving Pell grants who are math, science or social sciences majors may also be eligible for the Academic Competitiveness Grant (up to $750 for the first year of study and $1,300 for the second). Math and science students may also be eligible for the National SMART Grant (up to $4,000 a year for the third and fourth years of study). Both were introduced in 2006.
  • Federal Supplemental Education Opportunity Grants.These grants of $100 to $4,000 are reserved for the neediest of students. As with Pell grants, students apply through their colleges' financial aid offices.
  • State grants. Most states have some kind of free-money program -- again, often based on need, although some programs are also targeted to encourage study in certain areas. To find grants such as these and learn how to apply, check the website for your state's student-aid or higher-education commission.
  • Institutional grants. These grants come from the colleges themselves, and they are handed out when federal and state aid isn't enough -- or when the school is trying to discount its sticker price enough to attract a desirable candidate. Sometimes, colleges will substitute grants for loans to sweeten the deal for a sought-after student. Typically, you don't apply for these grants. But students can increase their chances for an attractive financial aid package by targeting schools that are likely to want them, rather than fighting to be admitted to a school that has plenty of other choices.

How to improve your chances

How can you improve your chances of getting a grant? The first step is filling out the Free Application for Federal Student Aid, or FAFSA, which you can submit online, find at schools' financial-aid offices, or have mailed to you by calling the U.S. Department of Education at (800) 433-3243.

Image: Liz Weston

Liz Weston

The earliest you can submit your form for the following school year is Jan. 1.

It's smart to file as soon as possible because many colleges' aid deadlines are in early to mid-February, and their reserves of grant money may have dwindled substantially by the time they actually stop accepting applications.

The FAFSA requires copies of your previous year's tax return. If you don't have that ready, you can include a return with estimated numbers and update them when you get better numbers.

Top forms

Your form will be sent to a federal center for processing. Once the numbers are crunched, you'll be sent a summary showing how much you're expected to contribute toward a college education. This is the figure your college will use as a starting point to build your financial aid application.

Many colleges require additional forms or information when handing out their own aid. Your college may require the PROFILE form, for example, which you'll be sending to the College Scholarship Service.

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For state aid, you may need to send in yet another form. State student-aid offices will have details.

For more information on financial aid, visit FinAid, The College Board or the Department of Education.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.