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The Law of Unintended Consequences, Student Loan Debt, and Housing – Oh, My!

Oct 03, 2014

Student Loans and Housing.jpg


Recently, I was reading one of John Mauldin’s excellent newsletters (you should definitely subscribe to his free newsletter) and came across this gem showing The Law of Unintended Consequences. In a nutshell, as shown in the infographic above, student loan debt is crowding-out housing as it reduces the borrowing power of potential homebuyers, especially young homebuyers.




I like how John Mauldin put it:


Government is necessary to the extent that we need to maintain a level playing field and proper conduct, but with the recognition that wherever government is involved there are costs for that service that must be paid by the private market and producers. For example, almost everyone thinks that the government’s being involved in student loans is a public good. We should help young people with education, right? Except that John Burns released a report this week that shows that student loans will cost the real estate industry 414,000 home sales. Young people are so indebted they can’t afford to buy new homes. Collateral damage? The unintended consequences of government policies and manipulation of the markets are legendary. But often unseen.


The authors of the study, Rick Palacios Jr. and Ali Wolf, at RealEstateConsulting.com summarized their study in a recent blog post titled “Student Loans Will Cost The Industry $83 Billion This Year”:


8% fewer homes will transact than normal in 2014, purely due to student debt.


This week, our clients received a 30-page paper that assesses the impact of student loans on home buying for households under the age of 40. Our conclusion is that 414,000 transactions will be lost in 2014 due to student debt. At a typical price of $200,000, that is $83 billion per year in lost volume.


The analysis was quite complicated and involved a few assumptions, but we believe it is conservative, primarily because we looked only at those under the age of 40 with student debt.


At a high level, the math is as follows:

 

  • Student debt has ballooned from $241 billion to $1.1 trillion in just 11 years.

 

  • 29 million of the 86 million people aged 20–39 have some student debt.

 

  • Those 29 million individuals translate to 16.8 million households.

 

  • Of the 16.8 million households, 5.9 million (or 35%) pay more than $250 per month in student loans, which inhibits at least $44,000 per year in mortgage capability for each of them.

 

  • About 8% of the 20–39 age cohort usually buys a home each year, which would be 1.35 million transactions per year.

 

  • Using previous academic literature as a benchmark for our own complicated calculation, we then estimated that today's purchase rate is reduced from the normal 8% depending on the level of student debt—ranging from 6.9% for those paying less than $100 per month in student loans to less than 1% for those paying over $1,300 per month. Other factors contribute to even less entry-level buying today.

 

While we applaud the increasing education, we need to realize that it comes with a cost known as student debt. We raised the red flag on student debt back in 2011 and continue to believe that this debt will delay homeownership for many, or at least require that they buy a less expensive home.


Of course, student loans also distort the economy in many other ways as well that also negatively impacts one’s ability to afford a home. For instance, student loans reduce the relative cost of attend a 4-year institution relative to a 2-year institution. Spending more time in school reduces earnings, since one is in school and not working, especially in careers that don’t really need a 4-year degree (nursing, trades, etc.). Also, the greater supply of people with 4-year degrees, some say a glut, reduces long-term wages.


This is why public policy must tread carefully when deciding to subsidize certain programs because the Law of Unintended Consequences is always hanging around. Without the subsidy on student loans, students would have a better understanding of the true opportunity costs of schooling vs. working. This would definitely result in a smaller student debt hangover that what we are currently experiencing today.



J. Scott Moody

Scott has nearly 20 years of experience as a public policy economist. He is the author, co-author and editor of over 180 studies and books. His professional experience also includes positions at the American Conservative Union Foundation, Granite Institute, Federalism In Action, Maine Heritage Policy Center, Tax Foundation, and Heritage Foundation.


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