Student loan debt is reported at $1.2 trillion nationwide, holding graduates back from fully participating in the economy, investing, and buying their first homes.
This debt level, which is reported to be second only to national mortgage levels, skyrocketed as home values fell and equity evaporated. News flash: they’re interconnected.
Prior to the recession, college was purportedly paid for through a variety of parent contributions including personal savings—in other words, cash. However, there’s a direct correlation between the decline in mortgage debt and the lack of available savings for college and the resulting student loan debt.
A home equity line of credit, or HELOC, is a mortgage product that was readily available prior to the recession and widely accessed nationwide. Parents would take out a home equity line of credit, use the cash to pay for college, and then sell the house or refinance after graduation. This process eliminated the debt that paid for college while statistically flying under the radar because tuition was paid “with cash.” In addition, since mortgage interest is tax deductible but college tuition is not, a HELOC was even more appealing.
After graduation, with the home sold or refinanced, parents could shed college debt by getting rid of the property, and the graduate came out debt-free and would also buy a home.
When the market crashed and HELOC loans were pulled off the shelves, called due, or frozen, students had no choice but to borrow for their education because their parents couldn’t borrow against the home. There was no equity to borrow against and no product to access it.
In short, this country traded mortgage debt for student debt.
Believe it or not, help for the student loan crisis can be found buried in the foreclosure crisis. As the crash unfolded and foreclosures began to flood the market at irresistible prices, buyers found that although they could get a ton of home for the price, the condition of many foreclosures was not within lending guidelines. So even though they could afford the home, it couldn’t be financed.
Along came FHA 203(k), a brilliant mortgage product that allows a buyer to borrow not only the price of the home, but add the cost of rehab on top of the price, all rolled into one fixed-rate, FHA-insured loan. The rehab portion of the loan is held back at closing and after FHA-required repairs are completed, the lender pays the contractor out of the rehab fund. The buyer ends up with a rehabbed property, a fixed payment, and without the need to come out-of-pocket for repairs.
A solution to the current student loan crisis is to apply this same concept: Introduce an FHA-insured mortgage product that allows the graduate to roll their student loans into their mortgage at the time of origination.
Yikes—allow them to borrow OVER the price of the house? Yes. Here’s how:
Introduce an FHA product that allows a college graduate to borrow up to 125% of appraised value (similar to HARP), but amortized over 15 years with a five-year commitment to stay in the property. The student loan debt is paid off at the closing table with the excess.
Let’s say a buyer finds a home priced at $200,000. Amortized over 30 years, the principal and interest at 3.74% would be $925.10. If the buyer borrows $250,000 at 15 years, the rate drops to 3% and the payment goes up to $1,726.45. That’s $801.35 more than the 30-year payment, but it creates $50,000 to pay off student debt. The higher payment is offset by the elimination of monthly student loan payments, and the interest is tax deductible.
After five years, the remaining balance on the larger loan amortized over 15 years would actually be lower than the remaining balance on the smaller loan amount amortized over 30 years. From there, the new homeowner is free to refinance or sell and is released of student debt.
It’s not just clever to come up with a way to help debt-laden young adults buy their first home, it’s critical. Current market conditions are like the eye of the storm. Anyone who thinks we’ve come out of this crisis needs to know there’s a second wallop coming.
As the baby boomer generation ages and moves into full-blown liquidation mode, the boomers will do what the boomers do best—they will set records. The market will see inventory levels like never before and that will require not only the maximum number of available first-time buyers, but also will require creative ways to maximize first-time buyer absorption rates.