There is a truism that youth imparts a feeling of invulnerability. Indeed, many young people will fly down flights of stairs, ski the break-neck slopes and eschew medical insurance more eagerly than their elders. Living in the moment is more common among teens and 20-somethings. Thus parents, grandparents, teachers and coaches admonish their youth about personal responsibility and investing for the future, sometimes to little avail. If any practice common to young adults, however, is sure to be of consequence in later years, it is the use of student loans. With Americans owing collectively 1.2 trillion dollars in these loans, they become a burden that affects college graduates for years to come, especially when trying to purchase a home.
Debt Service and Down Payments
When lenders underwrite loans, they calculate how the debt will service, i.e. how the borrower will pay down the debt based on current and projected income; other monthly obligations owed; and other assets held. In terms of student loans, those approving or disapproving the extension of credit want to see that a student can comfortably make regular payments upon graduating. The ratio of debt to income is crucial in making this determination. Yet student loan providers are not the only financial institutions making these calculations. Once a student loan is made, it, too, becomes a monthly obligation for others, namely mortgage lenders, to factor in.
The more money owed on student loans means the less available for a down payment and monthly mortgage remittances. True, young people benefit from mortgages guaranteed by the Federal Housing Administration (FHA), an agency of the U.S. Housing and Urban Development. Requiring only 3.5 percent of the purchase price down, these loans are understandably attractive to first-time homebuyers. On the other hand, lenders have their limits: most will hesitate to say yes to applicants whose debt to income ratios match or exceed 43 percent. A few might be slightly more generous. Saddled with too much debt, a prospective home buyer has borrowed herself out of contention.
Creditworthiness and Default
Debt service can damage the eligibility of college graduates even when they consistently make their monthly payments. Sometimes, though, the demands of re-payment and the lack of adequate employment opportunities create the perfect storm for default. In 2015, according to the U.S. Department of Education, 593,000 former college students defaulted on their loan repayments. Whereas paying on time and consistently enhances a credit profile, default can lower a credit score significantly, hurting job prospects, much less mortgage applications. There are, it is worth noting, programs to help renegotiate monthly student loan payments and thereby avoid the devastation of default.
What about Insurance?
According to the Wall Street Journal, property insurance premiums are climbing after remaining artificially low for a long period. This has profound ramifications on a figure known as PITI, i.e. principal, interest, taxes and insurance. Mortgage lenders underwrite loans to determine how well a borrower can manage this monthly combination of obligations. PITI grows larger when the home owner’s insurance premium swells. Since the property is the lender’s collateral, the loan is conditioned on you insuring your house, or else fire and flood can destroy the collateral, leaving no value for the bank to recoup.
Needless to say, student loan debt creates a built-in encumbrance when seeking to buy a house and live the American Dream. Yes, these loans can pull people from poverty and create opportunity where there was none. At the same time, they should be entered into prudently so their obligations do not become a drag when seeking credit later in life.