Is Increasing Student Debt Driving Home Prices Higher?

Question

Let me start by saying, I'm no economic expert. I read a lot, but so does everyone else on BP. This is my theory, and I'm interested what all the smart and experienced folks on BP think about it. So here it goes:

Student debt has quadrupled over the last decade. This article shows some stats. Why has student debt gone up? Because the price of education has increased. And the price of education has increased because the demand for education has increased dramatically. There are 1 million + 1 factors why demand for a college degree has increased, but simply put - it's a requirement for nearly every desirable job today. Shortly after the turn of the century, supply of education began trying to meet demand for a college education via online programs, new local/regional schools, etc... but that has done little to slow the education price hikes. So I ask you - how many folks can afford a $63K price tag per year (my alma mater's current tuition & room)? That's significantly more than the average household income. Suddenly the $15K guru seminar is looking much more appealing.... JOKING :)

Ok, so that explains the price of one economic market - the market of education. But how does this relate to the housing market? Well, let's rewind the clocks...

I'm a millennial - 26 years. Many moons ago, when my parent's were my age, a lot of people (I would dare to say 'most') didn't have the relative amount of student debt First Time Homebuyers (FTH) have today. When banks looked at our parents' financial picture and reviewed their existing debt obligations, there usually wasn't much personal debt the mortgage bank had to compete with. So, 20% down and near double digit rates was the norm. But this doesn't work for today's FTH's - they're already up to their eyeballs in student debt and don't have enough cash for 20% down. So to perhaps keep the housing market liquid, since it is the backbone of our economy at ~20% of the U.S. GDP, banks have come up with some brilliant ways for an entire generation of borrowers to keep buying homes (and getting into more debt). Enter the current financing landscape...

I believe it's safe to say low down payments and low interest rates are driving home prices sky high. I believe to counteract what should be healthy consumer hesitancy to buy a house (hesitancy in part due to student debt), banks have been offering unsustainable subprime mortgages. We have FHA loans which only require a 500 FICO. According to Ray Brousseau, an EVP at Carrington Mortgage Services, Carrington has been able to offer loans to borrowers with low FICO scores because the 'employees' have 'experience managing subprime loans'. Queue the groans from the skeptics. Also, BofA is now offering loans at 3% down. Of course, FHA can't be the only one attracting borrowers.

So what happens when interest rates eek up? How much of an impact does that have on prices? Are we poised to tumble due to the highly leveraged market?

I have no idea :) - which is why I asked you guys. Maybe I watched 'The Big Short' one too many times... Keep me honest folks and give me a clear picture.

Cheers,

-Marcel

David Dachtera · Answer

@Jaysen Medhurst,

The missing piece in your home buying scenario is the dearth of lending.

At the surface, it may appear that low interest rates and down payments are stimulating the market, there's actually another factor at work: the crash itself. In the crash, some 80% of home builders went under. Housing starts all but stopped while demand rolled on, unabated. Some economists estimate we are still some 5+ million housing units behind the demand.

Never mind "The Big Short". Look up a flick titled, "The Inside Job" and watch the banksters squirm as they admit - on camera - to causing the crash.

So, there's the demand and the supply, at a glance.

Now, consider that the lending market today is pretty tough compared to even before the build up to the crash.

Demand is driving home prices higher. the only thing keeping them from launching into inter-stellar space is the dearth of lending.

Now add student debt into the mix and it's a small miracle that ANY new graduates are getting home loans at all. With the tougher loan qualifications and the $Trillion+ of student debt (by some estimates), the fact that ANY new home loans are being made is small miracle.

... at least, that's MY take on it...

David J Dachtera

"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."- DJ Benedict

Marcel Duarte · Answer

Haha, I won't disagree with you @Jaysen Medhurst, my ears tend to perk up for a good conspiracy theory! I just find it interesting to think about how the debt obligations unique to younger generations may impact bank offerings and the housing market. Of course, that led to the rabbit hole which I elaborated on above :) As much as I may want it to, perhaps the big housing economic machine is far too complicated to fit into one theory.

I like your points about Population Growth and Urban Migration driving housing prices. I agree, I've been seeing the urbanization of Tampa, especially with FTH's, even though it's no where near the scale of a NYC or SF. Perhaps this is dipping too much into sociology - but what do you think is driving that urbanization? What will happen if/when that trend discontinues?

As for the ~20% of GDP number (RE residential investing and services) - I just mentioned it to highlight the volume of the housing market and how important the mortgage is to the banking industry. I'm certain there are better, more accurate numbers to make that point.

Thanks for sharing, Jaysen!

Jaysen Medhurst · Answer

Ha! I love it @Marcel Duarte, you have the conspiratorial leanings of a man 3X your age.

The reason that housing costs continue to rise faster than wage growth/inflation/GDP is simple supply and demand. Population growth (natural and immigration) is out stripping the increase in housing stock. Add to that population is moving out of rural/suburban areas and into cites (where there is less available land at an already higher price and more building regulations) and you have a case of simple economics.

That gets compounded yet again in dense/desirable cites (I live in Manhattan) where investment/ego purchases of luxury real estate displace other residents, push them to other neighborhoods, where they drive up prices.

I don't buy the low down payment/easy mortgage explanation. Wall St. doesn't make the same mistake twice this soon (there a whole bunch of new mistakes to make!)

Where did you get the 20% of GDP number? Existing home sales are not factored into GDP.

Fascinating discussion, thanks for getting it started.