Mar202012

Excessive student loan debt is another long-term drag on housing

When subprime borrowers defaulted and lenders foreclosed, the bottom fell out of the housing market. As the distress from toxic mortgage debt worked its way up the housing ladder, each subsequent rung collapsed. Only the upper tiers remain inflated, although probably not for much longer.

With the collapse of the bottom of the market, the equity vanished that is necessary to sustain the upper levels of the housing market. In order for the housing market to find a stable bottom, first-time homebuyers must come forward to absorb the distressed inventory. Unfortunately, the typical pool of first-time buyers composed of recent college graduates can’t find jobs, and many are burdened with so much student loan debt they can’t qualify to buy houses.

Student loan debt undermines mortgage lending

Posted by Jessica Huseman on 3/16/12 at 5:44pm

The rising amount of student loan debt is a startling figure. But probably more startling is the effect it could have on the overall economy. Should we call it the “student debt bubble”?

“We should all be concerned about young Americans burdened by excessive student loan debt,” said Rohit Chopra, the student loan ombudsman, at the Consumer Financial Protection Bureau. “Every dollar of interest and fees is one less dollar to save up for milestones that aren’t just important to us as individuals, but for the entire economy. If the current trends persist, we’ll see few people able to reach their dream of buying a home, starting a family, and living a comfortable retirement.”

Lenders truly have enslaved an entire generation — to the detriment of lenders as well. By enslaving recent college graduates, fewer will be able to sign up for the really big, long-term debt drain of a home mortgage. Lenders can still nickel and dime them with consumer debt — and they undoubtedly will — but between the credit cards and the student loan debt, lenders left nothing to save for a down payment or make a house payment. Perhaps the silver lining is that the few which can save enough to get an FHA loan will be limited to buying houses at or below rental parity. By burdening an entire generation with excessive debt, they limited their own ability to reflate another housing bubble.

What are these “milestones”? An article out Friday from AOL’s Daily Finance describes the plight of overly indebted recent grads that are unable to qualify for mortgages. Even if the student lands a job that pays well, banks are still wary of giving mortgages to young people in a lot of debt and little work history.

This creates a toxic situation in a world where the average student graduates college with more than $25,000 in student loans and probably don’t have a job that pays well, given that unemployment for those aged 20-24 is double the national average, and 30% of those that are employed are working in a job that doesn’t even require a degree.

There are many reasons for banks to take a chance on these young professionals. Giving them a mortgage to buy a starter home allows those who have outgrown their homes to move out and buy a new one, and having lots of new buyers on the market would certainly go a long way in clearing up the empty properties that have accumulated on the market.

People with no equity do not move out of starter homes. Such is the dilemma of falling house prices. Whether people believe they have outgrown their starter homes or not, they are stuck there for three to five years after the housing market bottoms — assuming they bought at the bottom — and the housing market hasn’t bottomed yet. It is a long, long road to recovery.

But, the bitter taste left by the thousands of people that defaulted on their mortgages and the $25 billion settlement that followed the crisis has made taking the risk pretty unappealing.

For now, it seems like those grads with big educations and equally big loan balances will have to stay in their rentals. The sad fact is, many grads won’t be very successful paying off those loans.

Figures from the U.S. Department of Education show that nearly 14% of student borrowers default within three years of making their first payment – an average that is skewed by the stunning 25% default rate of those that attended for-profit colleges. The rate 10.8% for those that attended public schools, and a lower 7.6% for those that attended private nonprofit schools.

Apparently, high-end private college education isn’t as lucrative as people hoped. A 25% default rate is astonishing. And since these debts cannot be extinguished in bankruptcy, whether these borrowers default or not, they will end up repaying this debt.

Given those figures, it may not be surprising that banks aren’t willing to give mortgages to recent graduates. And tips like saving for a down payment and “doing what you can” to establish good credit are useful, they don’t address the needs of the 14% of borrowers who are having trouble just making payments on their student loans. …

If 14% can’t make the payments at all, how many more are struggling to make payments and unable to afford anything else?

What about Federal debt relief?

 The recent changes in the federal student loan programs will not help housing much. The loan program limits repayment amounts to 10% of discretionary income, but since this debt is calculated as part of the back-end debt-to-income ratio, it still impacts qualification. Further, this repayment level will be sustained for 20 years before any remaining balance is forgiven. This is tantamount to a 10% hit on a borrower’s back-end DTI for 20 years. These students would have been far better served by not being allowed to accumulate that kind of debt in the first place.