By Melissa Condensa (NMLS# 1149324), Producing Branch Manager – Guild Mortgage and Member – CCAR’s Affiliate Committee
Inventory is tight and interest rates are going up, but could student loan debt be one of the biggest threats to home ownership for millennials? As our news feeds are filled with graduation pictures, it is worth taking a look at the amount of student loan debt that many young people are graduating with and the impact it can have on their ability to buy a home of their own.
The Wall Street Journal recently ran a story about the number of students who will graduate with over $1 million in student loan debt. The number of students with over $1 million in student loans for 2018 is estimated at 101, up from just 14 five years ago. That is clearly an extreme, but the average student graduates with $17,000 in student debt, and many are graduating with more debt than they will ever be able to pay off.
One reason people might never be able to pay off their debt is the program called Income Based Repayment. This repayment option allows people to make a small payment that is commensurate with their income. This payment is usually lower than an interest only payment, which results in a negatively amortizing loan. The lending institution wants their debt repaid, so the remaining unpaid interest is added onto the balance of the loan. While this makes the monthly debt more manageable, it also means the balance continues to grow each month.
How can student loans affect a person’s ability to purchase a home? First, there are potential buyers who will simply sit on the sidelines because they do not believe that they can afford to purchase a home due to their student loan debt. This may or may not be true, so it is always a good idea to have them meet with a loan officer to determine whether they can qualify.
There are also people who believe they can afford to buy a home, but in reality cannot because of their student loan payments. The ones most often impacted are people who are on an Income Based Repayment plan or whose loans are deferred. Most loan programs will not allow the payments on deferred student loans to be excluded from the debt to income calculation, and FHA for example, will not accept an Income Based Repayment plan for qualifying purposes. FHA requires that the lender use 1% of the outstanding loan balance, or the verified lowest fully amortizing payment to qualify the borrower to ensure the borrower can afford both their home and their student loans if they ever want to pay the student loans off.
Another major impact to someone’s ability to purchase a home are delinquent student loans. Potential homebuyers whose student loans are deferred, often allow them to become delinquent when they come out of deferment. Borrowers either do not realize, or are in denial about the fact that they need to start making payments or need to renew the deferral. Payment history makes up 30% of a credit score, so someone suddenly being 30, 60, 90 or more days delinquent on multiple student loans will see a dramatic decrease in their credit scores and limit someone’s ability to purchase a home.
There’s no arguing that a college education can set someone on the course for success in life, or that owning a home is a tremendous driver of wealth. We all need to find ways to help people manage both their debt and become homeowners. What can we do to facilitate both goals? First, let’s encourage young people not to borrow more than they absolutely need to borrow. Also, encourage everyone to do a cost benefit analysis on the degree they are earning and the amount they are going to have to spend to get it. Once they are out of school, we need to help them realize there are things they can do to ensure they can become homeowners. Rent adds up, so regardless of their situation, we should encourage young people to explore their options for home ownership.