Is Student Loan debt crushing the first time homebuyer?
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Student loan debt has risen from just $250 billion in 2003 to almost $1 trillion at the end of 2012. Student loan debt now exceeds auto loans, credit cards and home equity loans combined. The percent of 25-year-olds with student loan debt has increased from 25% to 43%, and the average balance has increased from $10,639 to $20,336. There is no doubt that this phenomenon will have economic effects, both short term and long term. In 2011, 57% of of all public school college graduates left with debt averaging $23,800. For graduates of private universities, 2/3 had outstanding student loan debt and owe $29,900.
Certainly some of the increase in student loan debt is due to the economy – graduating college students who cannot find a job are likely attending graduate school while they wait for the economy to turn around. The other driver is simply increasing college tuition, which has exceeded the rate of inflation by a large amount. Last year, colleges raised tuition “only” 4.8%, the smallest increase in 12 years. More people are attending college, so the increase is not explained entirely by increasing tuition costs.
High levels of student loan debt makes qualifying for a mortgage more difficult
Historically, people with student loan debt were more likely to have a mortgage. This makes sense – if one has student loan debt, they probably earn more and are more likely to own a home than rent. For 30 year olds, that gap was 4 percentage points in 2008. It has now gone to negative 2 percentage points.
High levels of student loan debt means lower credit scores. The average credit score for a 30 year old with student loan debt is around 630 – 635. For 30 year olds without student loan debt, it is between 655 and 660.
The ability to repay test makes it difficult for people with large amounts of student debt to qualify for a mortgage. Buyers must have a debt-to-income ratio (DTI) of 43% or less. If the borrower has a higher DTI ratio, they can come back and sue the lender if they default, claiming the lender gave them a mortgage knowing they would not be able to repay. The Obama Administration is pushing banks to lend more to people with weaker credit, in an effort to stimulate the first time homebuyer. FHA mortgages are also a product designed for the first-time homebuyer.
Impact on the homebuilders
The lack of first-time homebuyers has been one of the big issues for the housing recovery. Without first time homebuyers purchasing starter homes, the move-up buyer is largely stuck. The depressed level of household formation has been the driver of low housing starts. Even after this week’s big increase in starts, they are still at depressed levels, and starts for single family homes actually fell.
While this is a negative for homebuilders like Lennar (LEN), KB Homes (KBH) and Toll Brothers (TOL) in the short run, it will reverse longer term and will drive demand in future years. Also, since college graduates as a percentage of the population continues to increase, that bodes well for future earnings. While the homebuilders have faced serious headwinds over the past 5 years, the future is looking much better.