A. Institutional Background
Student loans are a popular way for Americans to pay the cost of college, and the use of such loans has been increasing in recent years. In 2005, 30% of 22-year-olds had accumulated some student loan debt, with an average real balance among debt holders of approximately $13,000. By 2014, these numbers had increased to 45% and $16,000, respectively. 5
The vast majority of students have access to federal student loans, which generally do not involve underwriting and can charge below-ount of such loans students can borrow is capped by Congress, however. Student borrowers frequently exhaust their available federal loans before moving on to generally more expensive private loans, often with a parent as cosigner. Historically, the typical student loan is fully amortizing over a 10-year term with fixed payments. Deferments and forbearances can extend this term, as can enrollment in alternative repayment plans, such as the extended repayment plan (available for borrowers with high balances) and income-driven repayment plans (which have become more common in recent years and are available for borrowers with elevated debt-to-income ratios), and through loan consolidation.
Student loan debt can impose a significant financial burden on some borrowers. Despite the inability to discharge federal loans through bankruptcy, 16% of recipients with outstanding federal student debt were in default as of ). Student borrowers are often young and at a low point in their life-cycle earnings profile. The financial difficulties may be more severe for students who fail to graduate. Of the federal student loan borrowers who entered repayment in 201112 without a degree, 24% defaulted within 2 years. 7
B. Theoretical Mechanism
We conjecture that three underwriting factors provide a channel through which student loan debt can affect the borrower’s ability to obtain a mortgage and, hence, enter homeownership. 8 First, a higher student loan debt payment affects the individual’s ability to accumulate financial wealth that can then be used as a source of down payment. Second, a higher student loan payment increases the individual’s debt-to-income (DTI) ratio, potentially making it more difficult for the borrower to qualify for a mortgage loan. Third, student loan payments can affect the borrower’s credit score. On the one hand, the effect can be positive: timely payments of student loan debt may help borrowers to improve their credit profiles. On the other hand, potential delinquencies adversely affect credit scores, thereby hampering borrowers’ access to mortgage credit. At the same time, other nonunderwriting factors might have effects as well. For example, from a behavioral perspective, if individuals exhibit debt aversion and wish to repay at least some of their existing debt prior to taking on new debt in the form of a mortgage, larger student loan debt burdens can further delay their entry into homeownership. Available evidence points to the existence of debt aversion in different settings, suggesting that this mechanism might play a role in reducing the probability of homeownership (see, e.g., Loewenstein and Thaler 1989; Thaler 1990; Field 2009; Palameta and Voyer 2010; Rothstein and Rouse 2011).
Various factors might influence how the effect of student loan debt on homeownership changes in the years after leaving school. Since cumulative balances are generally largest immediately on entering repayment (see fig. 15 in Looney and have a peek at this web site Yannelis 2015), there are at least four reasons to believe that the ceteris paribus effect of higher student loan debt on homeownership access might be largest immediately on school exit. First, given that the income profile tends to rise over the life cycle and student loan payments are fixed, the DTI constraint should ease over time, as should the budget constraint, thereby allowing the individual to potentially accumulate assets for a down payment at a faster rate. Second, once all debt is repaid, the student loan debt component of debt payments in the DTI constraint disappears entirely. Of course, the past effects of student loan payments on accumulated assets are likely to be more persistent if student loan payments significantly impaired the individual’s ability to save at a rate comparable to that of an individual with less student debt for a period of time. Third, the Fair Credit Reporting Act prohibits the credit bureaus from reporting delinquencies more than 7 years old, so any difficulties the borrower had meeting payments will eventually drop off her credit report. Last, any effect of debt aversion induced by a higher student loan debt burden at school exit should diminish over time as the balance is paid down. We articulate these mechanisms more formally in a model presented in the appendix.
