Student loan debt is rapidly emerging as the greatest long-term threat to the housing finance market.
Because the industry relies on the formation of new households, and because those new households are generally derived from younger Americans whose income and priorities are evolving, there is a certain reliance on consistent progress from the next generation in the cycle. But currently, that next generation is deciding against applying for mortgage loans in great numbers, opting instead to continue renting thanks in large part to the amount of debt it is already saddled with.
A disturbing cycle
According to Rohit Chopra, the student loan ombudsman for the Consumer Financial Protection Bureau, the amount of student loan debt outstanding in the United States exceeds $1 trillion. Perhaps more importantly, 81 percent of the most indebted borrowers - those with $40,000 or more still to be paid - are stricken with private loans to which interest rates of 8 percent or higher are attached. Repayment flexibility on such private loans is less common than on federal plans, and thus bankruptcy is usually not an option.
Chopra's recently released annual report revealed 3,800 complaints fielded between March 2012 and September 2013, and stated that CFPB measures have yielded a median relief amount of $470. But the current program, the impetus for which grew out of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011, has barely made a dent in the massive amount of debt still owed by Americans aged 25-34 - that which most immediately threatens the housing market.
During the so-called housing bubble, the U.S. housing sector was producing an average of 1.4 million new households annually. Conversely, in the depths of the recession, that figure fell to approximately 500,000 new homes per year. While gradual economic recovery and still-manageable mortgage interest rates have allowed for that rate to increase marginally - per a Time report on CFPB data, it currently sits around 700,000 new households per year - there are concerns that the room for further growth is limited. The 25-34 demographic is faced with the dual challenge of competing for jobs in a recovering employment sector while their student loan debts continue to accrue.
Macro concerns
"Three-fourths of the fall in household formation can be directly correlated to student debt," Chopra told a gathering at the recent ABS East Conference in Miami, where representatives from the securities market were in attendance. "We are already seeing signs of economic drag from student loan debt. The impact on the housing market is the most troubling part. The fact is that student indebtedness impacts the credit profile of first-time homebuyers. Three-fourths of the fall in household formation can be attributed to younger adults under 34."
While many recent home price surges were followed by a plateau effect that may manifest itself in renewed equity and a generally more sustainable pattern of market growth, the question remains: Who will step in to fill the available homes? Inventory levels are low in many of the metro areas that have experienced the most rapid rates of price appreciation, so the effects may not be evident immediately, but Chopra warns that that trend is potentially damaging on a macroeconomic level.
Not only are new borrowers hamstrung by their financial situations and a tenuous job market, they increasingly express hesitance to enter the fray based on skepticism - and sometimes outright fear - of the crediting institutions through which they must apply. It's one of the residual effects of economic downturn, and it is particularly evident in the number of young Americans (the potential new homebuyers) who continue to go the renting route.
In addition, the CFPB contends that the process for repaying student loans, particularly privately issued ones, is far more difficult than it should be.
"Repaying a student loan should be simple," said CFPB acting director Richard Cordray in a statement that accompanied the October report. "When servicers process payments to maximize fees and penalties they undermine the trust of their customers. Student loan borrowers deserve better; they deserve transparency and accountability."
The rate at which recent graduates are paying their student debts has not shown much progress, and that's the element of the issue causing the most concern. It even has some analysts predicting a "student loan bubble," not unlike the one that contributed to the housing crash.
Chopra addressed the potential parallels in the report: "Many of the student loan complaints mirror the problems heard from consumers in the mortgage market following the wake of the financial crisis… Consumers had difficulty refinancing their mortgages or had problems obtaining a modification of mortgage terms. Improper payment processing sometimes led to improper foreclosure."
In the interim, the CFPB will continue to try and assist indebted borrowers, and some lenders continue to make their best efforts to provide loan modification options. But unless some of the financial barriers restricting that segment of the population are removed, the household formation rate may continue to suffer.