Loose rust on tools is always an issue. This is particularly true if you work with antique tools (as some of mine are). I have used several techniques to restore such tools.
The most important thing to do first is to mechanically remove as much of the rust as is reasonably possible. This can usually be done best with a wire brush. Brass brushes are best, as they are softer than the tool steel and thus will not damage the steel itself (although they will remove paint and in some cases chrome or nickel plating). On smaller tools, use a brass brush in a Dremel tool, rather than a bench grinder. I feel that if the tool has a replaceable blade or bit, you are best off replacing it with a new one, unless it is an expensive tool, such as a splitter and the cost of the replacement blade is very high (Osborne Splitters, ~ $200 retail / blade!).
It is not advisable to paint or coat a cutting edge or bearing surface; however, as for the remainder of the tool, it should be painted with a good quality anti-rust pain, such as Rustoleum. If there was any surface rust remaining, before painting, use a phosphoric acid spray or gel (Rustoleum or Naval Jelly), which converts the rust to a durable, paintable phosphate coating. Always use a mask when spraying these products! I have used this technique to restore some very large, expensive Osborne arch punches. As I also do a lot of wrought iron work, I use these products a lot.
As a final note on restoration, consider that blades must always be very sharp to function properly and safely. It is worth the time to properly sharpen your tools. If you have not yet learned this important skill, consider one of Lie-Nielsen's excellent videos on sharpening using Japanese waterstones. If you are on a limited budget, look for a decent book on the subject in your local library.
Good Luck!
