Did Student Loan Debt Calculations Fuel A Housing Bubble That's Ready To Burst?

By ERIN FLYNN JAY

Mortgage loans have some risks, as do student loans. But the two don’t add up to a toxic combination that threatens to cause a price crash in the housing market, and trillions of dollars of damages for taxpayers to clean up.

A recent WSJ opinion piece by Allysia Finley claims taxpayers are standing behind trillions of dollars in risky mortgages due to the way that student loan debt is calculated during the mortgage process.

In “The Student-Debt Bubble Fueled a Housing Bubble,” Finley blamed student loan repayment plans, saying monthly payments are capped at 10% of discretionary income.

“Many student borrowers consequently aren’t paying down their debt, but it isn’t counted against them when they attempt to buy homes,” Finley wrote. “Take a couple with two kids that earns $75,000 a year and has $100,000 of student-loan debt. Under a standard repayment plan, they would have to pay about $1,150 per month. Under the Obama plans they would have to pay only about $250. If they apply for a mortgage, only $250 would be counted toward their debt-to-income ratio.”

Finley said that couple would qualify for mortgages with monthly payments $900 larger than they otherwise could if they were paying down their student loans in full.

Rick Sharga, president and CEO of CJ Patrick Company, said he’d be hard-pressed to call these loans risky.

Sharga said since the CFPB implemented its QM rules and Ability to Repay rules after the Great Recession, much of the risk has been taken out of the mortgage market.

As a matter of fact, mortgage delinquency rates have declined to nearly historically low levels. Only 3.37% of all mortgage loans were delinquent at the end of Q2 2023, according to the Mortgage Bankers Association, compared to typical delinquency rates that ranged from 4 to 5%.

Foreclosure activity, often a result of high-risk loans, is running at 60% of pre-pandemic levels. The MBA reported that 0.57% of mortgages were in foreclosure at the end of the first half of 2023, significantly lower than the historical average of 1 to 1.5%.

“Delinquencies and defaults are usually triggered by income disruption. A death in the family, job loss, divorce, unexpected medical bills, and unemployment rates generally have a very strong correlation to mortgage delinquency rates,” said Sharga. “Today’s 3.8% unemployment rate suggests that mortgage delinquencies and defaults are unlikely to be a major problem anytime soon.”

Plus, Fannie Mae is about to implement a new forbearance program (similar to the one implemented by the federal government during the COVID pandemic) allowing borrowers to skip payments for up to six months without penalty and Sharga said the FHA has a partial claim program that essentially allows borrowers to reduce monthly payments with a supplemental zero-interest loan due upon the sale of the property.

“And homeowners today have a massive amount of equity – more than half of homeowners owe less than half the value of their homes to their mortgage lender,” Sharga said. “In fact, 88% of homeowners in foreclosure have at least 20% equity in their homes. So, the ‘risk’ of homeowners being underwater on their loans is extremely low.”

If the risk factors cited in Finley’s piece really represented high risk, Sharga said we would have seen some fallout by now, since these risk factors have been in place for over a decade since the end of the Great Recession.

There is about $1.7 trillion in outstanding student loan debt, with the majority of that amount backed by the federal government rather than private companies, so taxpayers do face some risk if a lot of the borrowers suddenly default on those loans.

However, Sharga noted there was no indication of dramatic increases in delinquencies or defaults prior to loan payments being suspended during the pandemic.

Calculations on student loans didn’t fuel a housing bubble, Sharga said.

“The boom in housing was caused by historically low interest rates and demographically driven demand. Homeownership rates among borrowers with student loan debt are lower than homeownership for peers without student loan debt. Among first-time buyers, about 2/3 have no student loan debt,” noted Sharga.

This means there simply aren’t enough homeowners with student loan debt to trigger a large-scale default crisis.

“Relatively low homeownership rates by borrowers with student loans, low unemployment rates, low delinquency rates, historically low foreclosure rates – this isn’t an equation for massive defaults and pain for taxpayers,” Sharga said.

In terms of how student loan debt is treated by lenders, the debt is handled the same way as other debt.

Total debt is not factored into loan qualifications. Monthly payments are what lenders look at in determining a borrower’s debt-to-income ratio.

“In the event that a borrower isn’t making monthly student loan payments, the lender assigns 1% of the unpaid debt to the DTI ratio, similar to what a credit card company charges each month,” said Sharga. “Unlike other consumer debt, if a borrower defaults on a government-backed student loan, they won’t be able to qualify for a government-backed mortgage for a period of time.”

Affordability is the main thing that will continue to affect the housing market.

ATTOM CEO Rob Barber said according to their latest home affordability report, owning a home is becoming less and less affordable across the U.S., based on major expenses as a portion of wages.

“Our Q2 2023 home affordability report showed that major ownership costs – mortgage payments, property taxes, and insurance – on the median-priced $350,000 home consumed 33% of average wages nationwide during the second quarter of 2023,” said Barber. “That was up notably from 30% in the prior quarter and way up from 21% in early 2021.”

The reports also showed that affordability worsened as mortgage rates and home prices rose, pushing up major ownership expenses on typical home purchases from about $1,160 per month in Q1 2021 to $1,950 in Q2 2023.

According to the report, those expenses ate up at least half the average local wage in almost 20% of the county-level markets included in the analysis. Barber said the problem would be compounded if lenders start increasing the student loan debt amount used for mortgage applicants.