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Student Loan Bubble Blowback: Morgan Stanley Warns Average Debtor Can't Get A Mortgage

Via Morgan Stanley,

Amid rising tuition costs, an increasing share of students rely on debt to fund their education. Student loan delinquent balances have been on the rise since the early 2000s and those with student loans are likely to be less credit worthy than those without (Exhibit 50 & Exhibit 51). As a result, consumption for the student debt-laden population may be depressed. To be sure, the share of consumption driven by college age consumers has been in decline since 2003.

These challenges are further compounded under the Qualified Mortgage (QM) regulatory regime that became effective in January 2014. The QM definition relies on the back-end Debt-to-Income (DTI) ratio not exceeding 43%. This ratio takes not only mortgage debt servicing but all debt servicing into consideration.

Outstanding student loan debt has grown from around $375 billion in 2005 to over $1.1 trillion today to become the second largest outstanding category of debt. The first-time home buyer age cohort bears a disproportionate share of this burden – almost 60% of the outstanding student loan debt is owed by the under 39 age group.

As a result, despite the low level of interest rates, mortgage affordability for first-time buyers remains roughly at the long-term average levels whereas the aggregate home buyer's affordability remains well below the longterm average. As the servicing of student loan debt is part of the DTI calculation, the new regulatory regime compounds the already substantial challenges confronting the first-time homebuyer's access to mortgage credit.

We believe the average student debtor is likely unable to secure a typical home mortgage due to their debt-to-income ratio. A simple calculation yields startling results: the average student loan debtor's DTI ratio was 0.48 in 2012, up from 0.41 in 2002. With nearly half of their income going to debt payments, the average student borrower would face challenges qualifying for an FHA mortgage.

Researchers at the New York Fed have found that prior to the financial crisis, a positive correlation existed between student loan debt among 30-year olds and the rate of homeownership. The relationship suggested that someone with student loan debt was likely to be more affluent, having secured a well-paying job after college, and therefore be more likely to purchase a home.

But following the financial crisis, the authors found that the correlation had turned negative.

In other words, carrying student loan debt has become an impediment to home buying, primarily because the borrower no longer qualifies under stricter debt-to-income guidelines. Compared to their peers without student loans, 30-year-olds with student loans are much less likely to have a mortgage (Exhibit 52). In general, data from the New York Fed reveal higher credit risk scores (higher=better) for “no student loan” borrowers compared with borrowers that carry student loans (Exhibit 53).