How Student Loan Debt is Affecting the Housing Market
President Obama signed an executive order June 9th that will allow an additional 5 million borrowers with federal student loans to cap their monthly payments at just 10% of their income. The action takes effect in December 2015.
This order extends the option to borrowers who were not covered by previous legislation (the Pay As You Earn Program) that capped payments, including those who took out loans before October 2007. This action also allows certain low-income borrowers to have their balance canceled after 20 years of on-time payments, or after 10 years for those in public service (such as teachers, nurses, law enforcement, firefighters, and those in military service.)
This could help the housing market. With high student loan debt and lower incomes, it’s harder for first-time home buyers to purchase a home, which is slowing the housing recovery.
In his remarks last week, President Obama said over the last three decades, the average tuition at a public university has more than tripled while the typical family’s income has gone up just 16%. Student loan debt in the U.S. is more than $1.2 trillion, which now exceeds the amount Americans owe on credit cards. Only mortgage debt—now at $8.17 trillion—exceeds student debt in the U.S.
Interest rates for federal student loans are in many cases higher than the current rates for mortgages. Depending on the type of student loan and the disbursement date, the rates can be anywhere from 3.86% to 7.21%. Most federal student loans also have loan fees that are a percentage of the total loan amount, which is deducted from the amount of money the student receives. These fees can range from 1% to 4.3% of the loan. The borrower must pay back the total amount borrowed, not just the amount they received.
Student Debt Hinders Ability to Save for Down Payment
With more and more Americans putting large portions of their income toward payments on their student loans, fewer of them are able to save enough for their first down payment on a home. Americans who graduated in 2016 carry an average student loan debt of over $37,000- which is a 6% increase from last year.
According to a survey conducted by the National Association of Realtors in November 2013, 54% of first-time buyers reported student loans as the main difficulty in obtaining a home loan, compared to 38% who said credit card debt was the reason, and 31% who cited car loans as the main obstacle to getting a home loan.
Qualifying for Mortgages More Difficult
The official default rate for student loans is climbing: it’s at 14%, more than double what it was in 2007 according to The Department of Education. Unpaid student debt hurts potential first-time home borrower’s credit scores, making it hard to qualify for a mortgage.
Although interest rates continue to hover in the low 4-8% range, low housing inventory coupled with high demand for homes is pushing prices up across the state. And low credit scores as a result of late student loan payments can prevent borrowers from being eligible to get the lowest rates or getting a loan at all.
Another key factor in qualifying for a mortgage is a buyer’s debt-to-income (DTI) ratio. Current guidelines for Fannie/Freddie loans allow a DTI ratio up to 45%.For example, if you have a total monthly debt of $1,500 and a monthly income of $4,500, your DTI ratio is an acceptable 33%. For many graduates, however, high student loan payments can make their DTI ratios fall out of the acceptable range to obtain a mortgage. And DTI ratios are based on factoring in the borrower’s gross income, not net income. The unemployment rate of 5.6% for recent college graduates is higher than the national average, at 4.7% in February 2017. Underemployment rates are high for recent graduates as well, meaning their income levels are too low in relation to their debt to fall into an acceptable DTI range to obtain a mortgage.
Number of First-Time Home Buyers at Historic Lows
In a healthy housing market, first-time home buyers are an important segment of all home buyers, and recent college graduates typically have made up a large portion of first-time home buyers. First-time home buyers historically have made up 40%-45% of total home buyers. Yet so many college graduates are unable to become homeowners because of high student debt, which is causing a shortage of this crucial pool of buyers. The NAR reported that first-time homebuyers were only 35% of all home purchases in 2016.
According to data provided by the U.S. Census Bureau, the homeownership rate of Americans under 35 was 36.2% for the 1st quarter of 2014, down from a peak of more than 43% for the same period in 2005.
While lower monthly student loan payments could help many first time home buyers qualify for a mortgage loan, these measures don’t address other factors that affect homeownership such as the high unemployment rate for recent graduates and the trend toward young couples delaying marriage. Once this student loan bubble passes the housing recovery will gain more momentum, which we expect to take a couple more years.