The Connection between Student Loans and Housing

On July 1^st, among other changes, interest rates on newly originated Stafford student loans are scheduled to increase from 3.4% to 6.8%. Due to this looming deadline, there has been a lot of attention paid to the rising amount of student loan debt. Some of this commentary goes as far as saying that recent data indicate a bubble exists for student loans, one that will burst with negative consequences for housing and other parts of the economy.

The analysis below indicates that some of these claims may be exaggerated. It is true that outstanding student loan debt has risen. But the data suggest that, in part, this rise in explicit student loan debt is in fact a shift of the source of higher education financing – one related to housing itself. Namely, with the onset of the housing crisis, there was a decline in the availability of home equity loans, often used to finance higher education of children by homeowning parents or to finance other large expenditures, thus freeing resources for college expenses. Consequently, students are more likely to take out student loans on their own behalf.

The data thus do not necessarily reveal a sharp increase in borrowing for college education, but rather a shifting in the form of borrowing. And this is yet another consequence of the harm inflicted on the middle class as home prices fell, leading to a nearly 40% decline in median household net worth.

So much for the housing related cause.  What about the housing related effect? As I noted earlier, it is sometimes claimed the rising student loans burdens will cripple housing demand due to the financial burden of repaying these loans.

While it is clear that moving debt from parents to students means a reduction of available resources for housing and other spending for students who took out loans, the data thus far do not suggest that this effect will be as large as sometimes suggested.

More fundamentally, it would be a mistake to condemn the attainment of higher education itself, and even debt-financed higher education, as bad for the economy and housing demand. The data show that education continues to result in higher wages, which is good for housing.

With these conclusions in mind, let’s look at the actual data.

First, there’s no doubt since the onset of the Great Recession that student loan debt has been rising, while other forms of household debt have been falling, particularly outstanding mortgage debt. The following chart presents debt totals from Federal Reserve Bank of New York credit data.

Since the 3^rd quarter of 2008 (the farthest back the student loan debt data is available), student loan debt outstanding has risen by $293 million or 47.9%. All other forms of household debt, including mortgage debt, have fallen by more than $1.5 trillion, or 12.7%. This overall decline in debt is one of the factors associated with deleveraging or household balance sheet repair.

Some analysts have argued that the rise in student loan debt is a direct result of a bad job market, which results in more individuals attending school. This claim does not however explain the total rise in debt.

The following chart plots college enrollment, as reported by the Census Bureau’s Current Population Survey (through 2009) and projections/estimates by the Department of Education National Center for Education Statistics (for 2010 through 2012).  While there has been some increase in enrollment since 2008, 2.1 million or about 11%, this alone is not sufficient to explain the nearly 48% increase in student loan debt.

A better explanation, and one related to housing, is that the sharp rise in student loans is due the end of accessible home equity loans, as result of home price declines preceding, during and after the Great Recession. The chart below plots Federal Reserve Flow of Funds data showing the overall decline in home equity loans outstanding (note: these are levels, so the decline in overall home equity loan debt reflects paydowns of existing loans during a period of little new origination of home equity loans).

I think the chart offers fairly convincing evidence that part of the rise in student loan debt is connected to the decline in home equity loan debt. And this would suggest that the true economic debt total to finance higher education is not rising as fast as it would appear – that in fact, there has been a shift from parents’ balance sheets to students’ due to the inability to access home equity loans. Nonetheless, the loss of home equity loans cannot explain the total increase in student loan debt, but it can help explain the recent runup.

The other claim associated with a new bubble in the form of student loan debt is connected to rising delinquency rates.

It is true that the number of troubled loans has risen in recent years, as you would expect to be the case in an economic environment where unemployment for young people remains high (12.9% for people aged 20 to 24,compared to 6.9% for people 25 and older, according to May Bureau of Labor Statistics data). However, the delinquency rates have not yet reached crisis levels. The New York Fed data indicate that the 90+ day delinquency rate for student loans now stands at 8.69% as of the first quarter of 2012.

This is up 42% since the third quarter of 2008 (6.13% rate at that time). However, during the same period, the comparative delinquency rate for car loans was up 95% (from 2.33% to 4.55%) and for home mortgages up 450% (from 1.21% to 6.67%).

Given the high, but declining, levels of unemployment for younger people, it is possible that the number of troubled student loans will rise over the short-term, but it is likely an exaggeration to liken the current situation to a new economic bubble waiting to burst.

Nonetheless, given the transfer of college costs to students’ balance sheets and the higher level of delinquent loans, what are the possible impacts on housing demand, both rental and owner-occupied?

To get a sense of scale, it is useful to examine the amount of student loan interest that individuals are paying.

Statistics of Income data from the Internal Revenue Service give us some clues. Data from 2009, the most recent available unfortunately, suggest that the interest payment (which represents about 15% of the total loan payment under a 3.8% interest rate) is not a large portion of the typical payer’s budget.

There are some data limitations that obscure the complete picture. For example, the interest deduction is capped at $2,500 (representing interest on about $66,000 in student loan debt) and can only be claimed in full by taxpayers with modified adjusted gross income of $60,000 or less ($120,000 on joint returns). Nonetheless, the data do reveal some information on net burdens.

Nearly 75% of taxpayers (7.2 million taxpayers in total) claiming the student loan interest deduction in 2009 had adjusted gross income (AGI) of more than $30,000. For these taxpayers, the average interest deduction was $888, and basically ranged in average terms from $800 to $900 for taxpayers with less than $75,000 in AGI. For taxpayers with AGI between $75,000 and $100,000, the average interest deduction was a little higher – $990.  In general, the data suggest total loan balances of about $23,000 to $26,000 for those claiming the deduction.

Using these averages for interest payments, this suggests a total annual student loan payment for these taxpayers of about $5,900 (about $6,600 for the taxpayers with AGI between $75,000 and $100,000, and a little less than $5,900 for the rest).

In terms of household budgets, the burdens are definitely larger for lower-income taxpayers. As a percentage of AGI, the estimated student loan payment (interest plus principal) represented about 16% of AGI for taxpayers with AGI between $30,000 and $40,000; 13% for those with AGI between $40,000 and $50,000; 9% for those with AGI between $50,000 and $75,000; and 8% for those with AGI between $75,000 and $100,000. It is useful to keep in mind that student loans are typically 10-year loans.

The data are from 2009, and we know that loan balances are up since that time. Enrollment is up 11%, but debt is up 48%, so a reasonable guess would be that student loan payments are, on average, a little more than one-third higher per capita in 2012 than they were in 2009.

Certainly for student loan payers at the lower end of the income distribution, $30,000 AGI and less (about one-third of student loan deduction claimants), the student loan payment represents a fairly significant share of income, 25% or more on average after adjusting for 2012 data. This is high enough to negatively affect housing demand.

For the others, the share is more modest and should have minor impacts on housing demand. For example, for the median student loan payer, who has AGI between $50,000 and $75,000, the total payment in 2012 would represent about 12% of AGI.

So the IRS data and the Fed data on delinquency rates suggest that student loan debt burdens are, for the most part, not going to have a massive effect on housing demand. This is not to say that there are not cases where individuals obtain very large amounts of student loan debts and then find have trouble finding a job or a job with sufficient income to pay those debts. But the data suggest that these cases are the exception, rather than the rule.

Moreover, it is important for the housing community to remember the underlying economics of an educated, skilled workforce and housing demand. While it is likely the case that some returns to higher education represent signaling, employer preference for educated workers indicate that an educated worker has higher productivity. And productivity implies a higher wage. This is well known, and data from the Current Population Survey confirm it. In general, the more advanced the degree, the higher the average wage. Moreover, wages are rising faster over time for more educated workers.

Higher incomes allow for stronger housing demand. So to that extent, education, even reasonably debt-financed education, is a net positive for long-run housing demand, both rental and owner-occupied.

In summary, the connection between student loans and housing will certainly be examined in more detail by academics in the years to come when more detailed data become available. But today’s available data offers clues, and from those clues we can advance certain hypotheses and form tentative conclusions.

First, this issue is once again a reminder of the importance of housing wealth for the middle class. When that wealth declines, or otherwise becomes inaccessible (as is the case with home equity loans), it causes significant changes for the economy as a whole. The rise in student loan debt is a good example, where it seems to be the case the decline in home equity loans has resulted in some changes for how higher education is financed.

Second, debt used for investment purposes – including buying a home (residential capital), obtaining an education (human capital), and starting a business (business capital) – is economically justified and should not be penalized. Debt for these purposes is how people enter and remain in the middle class. This is a useful reminder given ongoing tax reform debates about the justifications of deductions for interest payments.