At work today, one of the higher up employees in the mortgage group was retiring. This could be in response to the mortgage business struggling to grow and continue their success, or it could be in response to his old age and wanting to be done with work. Either way, it got me thinking: will student loans be the catalyst to the next recession? How important is the student loans crisis?
Specifically, I want to think about this in terms of mortgages and buying houses. When the economy is going strong, houses are being built and bought, and families are being started. With student debt racking up, many people will have to put off buying a house or buy a less attractive house. To let everyone know, I don’t want to strike fear in anyone’s mind, or try to be a predictor of the future. What I hope to do is cultivate thought by running some numbers.
Let’s get some stats before we go into the numbers:
- The average American is graduating college with a student debt of $28,950.
- The average American makes $45,478 after graduating college.
- Mortgage companies are comfortable lending out loans as long as people stay under 36% debt to pre-tax income.
- I am going to use this House Affordability Calculator to illustrate my examples.
Let’s start by assuming a few things. Let’s assume that mortgage rates for a 30 year mortgage stay at about 4.5% for the next few years, student loan interest rates are about 7%, and wages grow at roughly 3% each year. Also, we require at least 5% down payment. We will also assume no prepayments of student loans.
First we need to calculate student loan payments. Most student loan payment plans are over a 10 year period. The estimated payment for a 10 year repayment plan is $349.49 a month. Next with a salary of $45,478, we have $3789.83 in pre-tax income per month. In addition, we are assuming no auto loans, no credit card debt, and no other debts (which most people have a least 1 or more of these).
So, our average American is already sitting at a 9% debt to income ratio the first year out of college. Let’s plug some of these figures into the House Affordability Calculator. Below are the results:
This analysis is slightly concerning to me. In Minnesota, a nice 3 bedroom/2 bathroom house in a nice area goes for at least 250k. For the average single person to afford a $250k house, you would need to save up a 20% down payment of $50k in cash and have an income of $55k. This wouldn’t happen until at least year 8, or when the average single person is 30. However, with the national personal savings rate hovering around 5-6%, good luck to the average single person getting to $50k in cash in 8 years!
What this analysis shows me, is that owning rental property will be important in the future as more people are forced into renting (lenders may not want to give loans to younger people due to higher debt-to-income ratios). However, you never know, a correction may happen, rates drop, housing prices drop, and many people could start buying houses!
A few questions I’m pondering on after doing this analysis:
- Will smaller lenders loosen their lending policies to keep mortgage origination going even if the prospective borrowers are less than optimal?
- Will property prices start to come down slightly as more people go to renting?
- Will the economy start to perform well due to new policies put into place by the newly elected politicians, pushing houses higher as people have higher wage growth?
There is a lot that can possibly happen. I guess we will have to wait and see.
What do you think about this analysis and topic? Will student loans weigh on the economy significantly? Will the benefits of student loans outweigh the negatives? Let me know what you think in the comments; I would love to know what you are thinking.