Is front-end interest a student loan rip-off?

We might suggest that the Star Tribune commentary on student loan debt perfectly shows why courses on personal finance might not be a bad idea in high school.

Bill Boegeman, a social studies teacher, was surprised to find out how little principal has been reduced after a year of paying his student loan.

Here’s the part that really makes me mad: For 12 months, I have been making student loan payments of just over $500 a month. That means that over the course of a year, I put about a $6,000 dent into my student loan debt, or so I thought. On Oct. 17, 2015, a year to the day after I began paying off my loans, my total student loan debt was …


If you don’t have a calculator handy, that adds up to just under $700 less than I owed a year ago— $700 out of the $6,000 I put in that actually went toward reducing my debt. That’s about 11 percent of the total amount paid, just enough to reduce my total debt by almost 1 percent.

Where did the other 89 percent ($5,300) go? Interest.

That’s messed up. I mean, c’mon, man, I understand interest. That’s why loans exist. The lender needs to see a return on their investment. I get it. But this is more than a return. This is a rip-off.

Not exactly; it’s how loans work. Interest is paid at the front end of a loan — student loans, car loans, and mortgages.

I don’t expect people to feel bad for me, a middle-class white guy who, immense student loan debt aside, has it pretty good. However, I do expect people to be angry at those financial institutions that are keeping me, and millions of others like me, from having it a little better. Those white-collar crooks who rig the game in their favor and then force us all to play. Those lenders who are preying on the vulnerable, exploiting those in need of help for their own personal gain, and exacerbating the enormous gap that already exists in this country between the haves and the have-nots.

In truth, the lender collects exactly the amount of interest the borrower agreed to when taking out the loan.

The “Mortgage Professor” explained that if lenders make big bucks by front-ending loans, then a longer-term loan would be more preferable for them. And yet, they charge a higher interest rate for longer-term loans.

… the way that lenders price loans is just the opposite of what we would expect if interest was front-end loaded. Lenders actually prefer shorter term mortgages because their money turns over faster, which reduces their exposure to rising interest rates, and the more rapid pay-down of the balance reduces the risk of loss from default. Mortgage lenders have enough to answer for without saddling them with a charge that is wholly bogus.

The FAMEMP, which is the basis of the front-end loading argument, was really designed to meet the needs of borrowers. Consider the alternative ways of paying off the $100,000 loan referred to earlier. One way, which was very common during the 1920s, was for borrowers to pay interest only until the end of the term, at which point they had to pay the entire balance. If they could not refinance, which was frequently the case during the 1930s, the alternative was usually foreclosure.

At the end of the student loan term, the monthly payment goes almost entirely to principal. The writer’s interest amount on his last payment of $500 will be about $2.73. Does this mean the borrower is ripping off the lender? Of course not.

But none of this should surprise anyone taking out large student loans. Amortization schedules and payment tips are easily available online.

There are plenty of “rip-offs” in getting and paying for higher education. But the amortization schedule isn’t one of them.