Updated May 15, 2019. Original copy posted June 2014.
Student debt is generally incompatible with mortgage financing, as it negatively affects the homebuyer’s debt-to-income ratio (DTI). However, about 70% of college graduates have taken out student loans, according to the College Board. Thus, most of your college-educated clients must weigh their home purchase with:
- the college debt they still carry; or
- their reduced savings (in the form of smaller down payments) if they have already paid off their student debt.
This is true across most demographics, as:
- 40% of individuals with student debt balances are under 30 years old;
- 42% are 30-50 years old; and
- 17% are older than 50.
Student debt is everywhere — and it’s already cutting into your potential client base.
Why do so many people have student debt?
There are two reasons behind the rising trend in student debt:
- the cost to attend college continues to increase quickly; and
- the number of individuals attending college continues to grow.
To get specific, the average tuition and fees for a four-year public college or university in California during the 2006-2007 school year was $4,549. Five years later, in 2011-2012, it was twice that at $9,022. During the same time period, average tuition and fees rose by a smaller (though still significant) 42% nationwide, according to the College Board.
The number of individuals attending four-year public colleges or universities in California grew 16% from 2000 to 2010. In 2010, there were 642,000 students enrolled in public four-year institutions in California.
Editor’s note: The differences between colleges and universities are slight and mainly organizational. Student loan statistics do not vary based on whether the four-year degree-granting institution is labeled a university or college. However, public and private institutions present a difference, as tuition and fees are much higher at private institutions.
In years past, the U.S. government paid for the college education of many young people. The most significant instance has been through the GI Bill, passed in 1944. This bill provides for the education of service members, as well as loan guarantees for homes and businesses. Following World War II, students attending school on the GI Bill made up half of all college students, according to the U.S. Department of Veterans Affairs. When these students graduated, they were able to obtain higher paying jobs and pay for amenities they wouldn’t have otherwise had access to (like homes). The housing boom of the 1950s ensured a jump in the homeownership rate that lasted for decades.
Fast-forward to today: The latest statistics have students attending college with GI Bill benefits at roughly 270,000 students, according to the Chronicle of Higher Education. With 21 million students currently enrolled in degree-granting, postsecondary institutions nationwide, that’s about 1% of all students enrolled under the GI Bill. The difference is troublesome for future homeownership rates, particularly for Generation Y (Gen Y).
The problem for housing
While alarming in a general sense, the rising tide of student debt presents a tricky obstacle for California’s housing market.
On the one hand, higher education is essential to obtaining a high-paying job. For instance, the median wage for four-year college graduates is twice the median wage of those with only a high school diploma, according to the New York Federal Reserve. In turn, these jobs are a great boon to local housing markets. Areas with high-skilled jobs requiring college degrees foster higher home prices and rents and more stable demand from end users.
However, when obtaining a college degree means accruing thousands of dollars of debt even before starting a career, a home purchase (particularly in high-priced areas where the best jobs are located) is often beyond reach.
As evidence, the decrease in the first-time homebuyer demographic (those aged 25-34) corresponds with the swift rise in student debt.
Chart update 05/15/19
To be fair, the decline in homeownership amongst the traditional first-time homebuyer demographic (currently made up of members of Gen Y, AKA “Generation Renter”) can also be attributed to a number of factors. These include:
- persistently high rates of unemployment in the wake of the 2008 recession;
- for those who can locate employment, underemployment in jobs for which employees don’t even need college degrees; and
- of course, the reduced savings and decreased ability to make housing payments due to the ever-increasing weight of student debt.
The good news: In 2016-2017, homeownership rates began to rebound for young adults. This follows a decline in the number of student loan borrowers which began in 2013.
Student debt’s continuing impact
First-time homebuyers are slowly making their presence known in the market in 2019. As student loan balances are paid off and savings accumulated, greater numbers of first-time homebuyers will pour in. By 2020, the employment picture will have improved enough to support larger numbers of first-time homebuyers (ironically, just in time for the next recession to arrive). Simultaneously, Baby Boomers retiring and relocating to smaller residences will usher in the Great Confluence of home sales.
However, even as first-time homebuyers return in greater force at the end of this decade, their numbers will continue to be slightly stunted by the drag of student debt.
For example, consider a potential first-time homebuyer who is a recent college graduate. Their gross monthly income equals $4,000. Their monthly student debt payment is $340 (based on the New York Federal Reserve’s estimate for the average U.S. student debt load of $29,364 for a 30-year old borrower, paid off over the default repayment plan of ten years).
However, on top of their student debt payments, this borrower is also making car payments totaling $300 per month and has monthly credit card payments of $100 a month.
This individual’s monthly debt totals $740. Thus, their current DTI is 19%.
A homebuyer’s maximum DTI, including housing costs and all other debts (the back-end ratio) is 43% of their monthly income. Thus, in this scenario it’s possible they may qualify for a maximum monthly mortgage payment of 24% of their monthly income (the front-end ratio) – $960.
With this monthly payment, they qualify for home purchase of roughly $180,000 – but only if they come with a 20% down payment. In this case, coming up with a 20% down payment ($36,000) is unlikely, particularly when nearly 20% of their monthly income is already going toward paying down pre-established debt. Further, home prices are well above the maximum this homebuyer qualifies for in most of California.
The options for homebuyers with student debt
In most cases, student loan borrowers are set up for ten-year repayment plans. This means a set amount of their monthly income will go towards paying down their debt for a full decade. However, this doesn’t necessarily preclude them from buying a home until their student debt is wiped out.
One less than ideal way is to wait until their income rises. In a couple years, our borrower earning $4,000 a month may be earning $5,000 a month. This brings their pre-established debt from 19% down to 15%, bringing their acceptable front-end ratio from 24% to 28%. This brings the potential purchase price of their home up a few thousand dollars, while also giving them more time to save for a larger down payment.
However, at this point they may be better off simply waiting for their student loan payments to cease (again, this takes an average of ten years).
Another reason why waiting for their income to rise won’t always work: Half of student loan borrowers have higher debt payments than the individual in our example. Some of them have much higher debt loads. 13% of borrowers have a student loan balance of at least $50,000. 4% of all borrowers have balances greater than $100,000. Further, many households consist of spouses who each carry their own student debt loads, meaning there are two student loan balances to contend with.
Households carrying extra heavy student debt loads often have difficulty even keeping up with their payments, forget saving up for a down payment. This is evidenced by the roughly one-third of student loan borrowers in the repayment stage of their loan who are 90+ days delinquent on their loans, according to the New York Fed. This delinquency rate is nearly double what it was ten years ago.
So is there no hope for the student-debt laden homebuyer? Is a real estate agent’s best counsel really to “wait it out?” Not necessarily.
Change repayment plans
Borrowers who find themselves overwhelmed with their student debt payments have a few options beyond defaulting (and sinking their credit scores).
The Pay As You Earn student loan repayment plan caps a borrower’s monthly payments at:
- 10% of their monthly income; and
- extends the length of repayment from ten to 20 years, at which time the remaining loan balance is forgiven.
To qualify, the individual must be a “new borrower,” defined as an individual:
- with no Direct Loan or Federal Family Education Loan (FFEL) balance as of October 1, 2007; and
- who has received disbursement of Direct Loan funds on or after October 1, 2011.
Further, to be eligible for the plan, their new payments must be lower than under the standard repayment plan. Monthly payments are adjusted each year depending on the borrower’s changing income and family size, but will never exceed 10% of their household’s monthly income. For more information, see the U.S. Department of Education.
If your buyer clients don’t qualify for the Pay As You Earn program, they may qualify for the Income-Based Repayment plan. This program:
- limits borrowers’ monthly payments to 15% of their monthly income; and
- extends the repayment period from ten to 25 years, at which time the remaining loan balance is forgiven.
To qualify, a borrower must simply have an outstanding loan balance on any Direct Loan or FFEL loan. Monthly payments are adjusted each year depending on the borrower’s changing income and family size, but will never exceed 15% of their household’s monthly income. For more information, see the U.S. Department of Education.
Finally, if your client works full-time for a federal, state or local government agency, or not-for-profit organization designated as tax-exempt then they may qualify for the Public Service Loan Forgiveness Program. This program can work jointly with the Pay As You Earn or Income-Based Repayment plans, by:
- limiting the borrower’s monthly payment to the applicable reduced payment amount; and
- capping the repayment period at ten years, at which time the remaining loan balance is forgiven.
To qualify, a borrower must have an outstanding loan balance on a Direct Loan. FFEL loans are not eligible. They must make all payments in full and on time. For more information, see the U.S. Department of Education.
An agent’s solution
All things considered, there are no quick fixes for the massive and mounting burden of student debt. However, a real estate agent confronted with a client who wishes to buy but fears they can’t qualify due to their student debt has a few steps they can take:
- Create a profit and loss statement with your buyer client, detailing their monthly income and debt payments to figure their DTI. [See RPI Form 209-2]
- If their DTI exceeds acceptable levels to qualify for a realistic mortgage amount, tell them about the different student loan repayment plans, which can lower their DTI.
- Shift your outlook to the long-term. With Gen Y’s delayed entry into the job force in the aftermath of the 2008 recession, they will need more time to save up for down payments and build the good credit necessary to qualify for a mortgage. Thus, even if your potential buyer client must continue renting today, don’t give up on them.
- Make a list of current renters who are unable to buy due to debt. They will eventually be financially able to become homebuyers, it’s just a matter of keeping track of them until then. In the meantime, send FARM materials regularly and check in with them every so often to keep your name fresh in their minds. If you find your list of renters becoming lengthy, you may even consider adding property management to your list of skills.
Student debt is here to stay — and it continues to grow. Stay ahead of the competition by branding yourself an expert in assisting homebuyers with student debt.