In days of old, getting a college degree was a standard fixture of the American Dream, along with a good job and a home of one’s own. But over time, the cost of obtaining that degree went up — increasing an inflation-adjusted 800% from 1982 to 2012 according to the National Center for Education Statistics.
Over the same three decades, inflation-adjusted income increased by 240% according to the U.S. Census Bureau. This is great, but much less than needed to keep up with rising college costs.
70% of students take out student loans to pay for their education according to the College Board. These students leave school with an average student debt load of $25,000 according to the Federal Reserve Bank of New York. Those with graduate degrees have even more debt to their name.
The heavy burden of student debt has dragged down the housing recovery here in California and across the U.S. Young adults have put off purchasing their first home by necessity, as a significant chunk of their income goes toward paying back student debt (and the remainder often goes towards paying too-high rents).
Choose your debt burden
A college degree still conveys a higher paycheck. But now that student debt eats away at said paycheck, many areas of the country are seeing non-college educated individuals beating college graduates to the homeownership game. Most of these areas are in the Southern part of the U.S., where home prices are low and the difference between college educated earners and other is less pronounced, according to a recent Trulia study.
To get the findings, Trulia used region-specific data and assumed young adults are:
- saving 10% of their annual income to put towards a full 20% down payment;
- making the median income for their education level as it is projected to change over time; and
- will pay the median home price for each area, as it is projected to change over time, calculated by the Federal Housing Finance Agency (FHFA).
For those with college degrees, researchers subtracted the average student loan payment amount from the 10% saving contribution. However, since college grads tend to have higher incomes than non-grads, the reduced saving ability of college grads may be canceled out by their higher incomes, depending on their location in the country.
What’s most startling in the Trulia study is this: in high cost areas (read: California) college grads and non-grads alike have to save up for longer than ever to make a full down payment.
Small down payments are the future
In California, there’s no question about whether it’s better to be college-educated or not. The time difference to save up for a full 20% down payment is huge between college grads and those without college degrees. For a college grad, it takes an absurd average length of:
- 29 years to save in San Francisco, compared to at least 50 years without a college degree;
- 19 years in Los Angeles, compared to 40 years without;
- 19 years in Orange County, compared to 32 years without;
- 18 years in San Diego, compared to 29 years without; and
- 18 years in San Jose, compared to 45 years without.
That’s right, even with a college degree it will take an unprecedented amount of time for today’s young adults to become homeowners (in most parts of the country the wait is much shorter). Without a degree, it’s nearly impossible. Of course, that’s with a full 20% down payment, which homebuyers can (and will) easily sidestep by tacking on mortgage insurance, either through the Federal Housing Administration (FHA) or through a private lender.
Further, if today’s student debt crisis has taught us anything it’s that consumers are willing to take on extra debt to fulfill their American Dream of a college education and, probably, homeownership. Therefore, smaller down payments requiring mortgage insurance will become the new normal over the next few years, despite the requisite higher interest rate. Generation Y (Gen Y) will settle for less house than their parents’ generation, and will end up shouldering more debt to get it.
In the meantime, young adults can watch their credit closely to ensure the best terms when they are finally able to become homebuyers. Qualifying for a relatively low rate is important since a lower mortgage rate frees up more of their monthly payment for home principal — especially significant in the coming years as mortgage rates increase.
Another tip is to tell homebuyers to aim for at least a 10% down payment, which is much more manageable a goal for today’s renters than 20%. With 10% down, mortgage insurance premium (MIP) payments for an FHA-insured mortgage are canceled after 11 years of payment — much better than a smaller down payment, which locks the homebuyer into MIP payments through the life of the mortgage.
Real estate professionals can pass other tips on to prospective first-time homebuyers having a hard time saving or qualifying due to student debt. These include enrolling in an income-based repayment plan or the government’s Pay As You Earn program. Check out strategies for tackling student debt and attaining homeownership here: Student debt weighs down the housing market.