It is hardly news that the student loan crisis has reached epic proportions in the United States. College loans are now the second largest category of personal debt after mortgages, having eclipsed credit cards in 2010 at $830 billion. Today, the total has reached a staggering $1.5 trillion, an 80 percent increase in eight years. The crushing load now threatens the American dream of home ownership for many members of the millennial generation.
The home ownership rate in the U.S. currently stands at 62 percent. But among millennials, it's just 35 percent. Many factors contribute, including a trend toward a later start in establishing a family. But according to a survey conducted by the National Association of Realtors, 83 percent of those who do not own a home say student loan debt is shutting them out.
Recognizing this obstacle to home ownership, some government housing entities have adjusted their underwriting standards to make it easier to qualify for a mortgage by modifying their consideration of college loan payments.
The Federal National Mortgage Association (FNMA), known as Fannie Mae, is the largest quasi-governmental home lending agency. Along with its cousin Freddie Mac, FNMA provides roughly half of all the money available for making mortgage loans in the U.S. by buying up home loans initiated by commercial banks and mortgage originators. In order to provide a secondary market, FNMA has established lending standards banks must follow if they plan to sell a mortgage to Fannie Mae. Millennials have found it difficult to qualify under those standards if they carry substantial student loan debt. In response, Fannie loosened the rules a bit last year to provide some relief in how student debt is treated.
One principal metric for evaluating a borrower is the debt-to-income ratio or DTI. This is a number determined by dividing a borrower's total monthly debt service payments (principal and interest) by their total monthly income. Debt service also includes minimum credit card payments, HOA fees, property taxes and mortgage insurance.
The federal government specifies a maximum DTI of 43 percent to automatically qualify a mortgage as eligible for resale to Fannie or Freddie. But given the increasing burden of student loan payments, FNMA relaxed the method by which such payments are tallied in the DTI calculation, recognizing the growing popularity of extended repayment plans based upon income. Previously, lenders had to use a government formula that overstated the actual student loan payment on these newer repayment plans. Now they may consider the actual payment from a credit report or from documentation provided by the student loan servicer.
In addition, Fannie boosted the maximum DTI to 50 percent under certain circumstances (excellent credit history or large cash reserves). These provisions have opened the door to more borrowers.
Of course, just because one can borrow more does not mean one should. Experts generally recommend a DTI of no more than 35 to 40 percent as a prudent limit. Fannie and Freddie appear to be repeating some of the mistakes that led to the financial crisis, by facilitating additional borrowing by those already carrying a lot of debt. Meanwhile, several providers of mortgage insurance are pushing back, refusing to issue private mortgage insurance in cases with a DTI in excess of 45. Mortgage insurance is a requirement when the down payment is less than 20 percent.
The fundamental issue is not overly restrictive mortgage standards for recent graduates. This issue is suffocating debt incurred in reaching graduation that saddles millennials for years to come.
Next week, a closer look at the causes and effects of the student loan crisis.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager at Barnett & Co., in Chattanooga.