Middle Class Homeowners Are the Biggest Winners from Student Loan Forgiveness

A lot of the criticism of Senator Elizabeth Warren’s student loan forgiveness proposal has focused on how it's not fair to give loan forgiveness to current borrowers when past borrowers repaid their debts.  That criticism overlooks the enormous boost Senator Warren's proposal would give to the real estate market. Many previous borrowers are homeowners, and homeowners are going to be one of the major beneficiaries of any student loan debt forgiveness as their home equity value will increase because of the increase in housing demand from deleveraged student borrowers.  

By my calculations Senator Warren's proposal for $640 billion in student loan forgiveness could readily translate into $1 trillion of increased home equity value plus an additional $320 billion to $680 billion in GDP growth. That's an amazing win-win-win for student loan debtors, for homeowners, and for those in the home building and furnishing trades.  

It is widely recognized that student loan debt is depressing demand for housing.  The depressed demand seems to work through multiple channels.  Large levels of student loan debt impair borrowers’ credit capacity and may prevent them from qualifying for loans.  Student loan repayment burdens may impede borrowers’ ability to save up downpayments for home purchases.  Additionally, borrowers may be discouraged from even entering the homeownership market because of the psychological burden of large debt balances, even if their monthly mortgage payments would not differ materially from rental payments.   

It's clear that student loan forgiveness will have some upward pressure on home prices.  But how much?  The Warren proposal is estimated to result in $640 billion in student loan forgiveness. There are two groups who will have demand constraints loosened through loan forgiveness:  those who have been kept out of the homeownership market entirely, and those who are in the market, but have had to purchase less home because of their student loan debt. It's not to hard to get a sense of the size of those groups, and from that we can estimate the impact on their demand from loan forgiveness.  

A Federal Reserve Board staff study estimates that student loan debt has kept 400,000 borrowers out of the homeownership market—roughly 1% of student loan borrowers.  to this group of borrowers, it's necessary to add the depressed borrowing capacity of individuals with student loan debt who are already in the homeownership market.  

The Federal Reserve Board's 2016 Survey of Consumer Finances indicates that 39% of households have a mortgage and 21% of mortgage borrowers have student loan debt (you'll have to either take my word for this or download the data and crunch the numbers). There are 127 million households in the US, so that means that 10.4 million households (21% of 39% of 127 million) would be able to afford more home if they weren't paying off student loans (their own or their children's). So together with those individuals who are kept out of the market, let's say that we have 11 million folks whose homeownership demand is depressed because of student loan debt.  That's a quarter of the 44 million student loan borrowers in the US!  

Let's assume an equal distribution of student loan debt within this population (and I know that's a problematic assumption--it probably skews on both ends, but I don't know how to correct for it).  Thus applying that 25% figure to $640 billion, we get to about $160 billion of unleashed demand through student loan forgiveness.  And now the story gets fun.  

That $160 billion gets leveraged at 10x with 90% LTV mortgage borrowing, so it's actually pouring $1.6 trillion into the home market.  Now, I suspect that this $1.6 trillion estimate is too high--not all of those people will turn around and borrow for more home if their student loans are forgiven.  Let's impose a generous haircut and say there is only $100 billion in increased demand.  Given the leverage in the market, however, even if there's only $100 billion in additional demand, it gets leveraged into $1 trillion in increased home prices.  

Relative to a $29.5 trillion home equity market, an extra $1 trillion in demand results in a 3.4% increase in average home price.  And if I'm still overestimating by 50%, it nonetheless results in a 1.7% increase in average home price.  That's still nothing to sneeze at.  

Now notice that very little of this increase will flow to McMansions and $1M+ houses.  It will instead flow primarily to entry-level homes up to the middle of the market:  homes priced at $100 thousand to the high hundreds of thousands.  There will be some trickle-up effect, as existing owners parlay their home equity value increases to buy into the upper end of the market, but the gains will still be most concentrated in the more modest end of the market.   In other words, Senator Warren’s $640 billion loan forgiveness proposal will likely result in a $1 trillion wealth increase among homeowners, and that increase will be concentrated in the lower-end of the homeownership market—the heart of the middle class.

If I'm right here (and there's no doubt I am directionally--the only question is magnitude, and others might have a more refined take on the data), this suggests that the constituency supporting the Warren proposal should not be just those with current student loan debt, but homeowners, a group that includes many individuals who were once student loan borrowers and paid off their debt.  While they are not getting the debt forgiveness themselves, they are in fact benefitting from it more on total dollar basis than those with student loan debt. Put another way, American homeowners should be cheering for Senator Warren's proposal louder than anyone.  

Also, notice that my analysis up to this point isn't even attempting to take into account the positive spillovers into the home construction and furnishing markets—there's a huge positive multiplier effect from home purchases. The National Association of Realtors estimates that ever additional $1 spent on home purchases results in another $1.32 to $1.64 in GDP.  So here, there should be an additional $320 billion - $640 billion in GDP growth from the debt forgiveness.  

Getting a $1.32 trillion boost (or more) in GDP from $640 billion in loan forgiveness is a win-win proposition, the sort of rising tide that lifts all ships. That's a policy home run. 

[Update:  I have another way of thinking of this. The average Survey of Consumer Finances mortgagor with student loan debt had $38k in student loan debt, but about $102k less in mortgage debt than mortgagors without student loan debt. That suggests that $1 less in student loan debt translates into about $2.68 in greater mortgage borrowing. Again, assuming 90% LTV borrowing, that turns into a $3 increase in home prices for ever $1 of student loan debt forgiveness for those student loan debtor who are already mortgagors.  That's a much smaller leverage magnifier than above, but it still gets us to nearly $500B in home equity increases, which is still almost a 1.7% increase in home prices.]

 

Comments

[Colin Linsenman]

Adam,

I'm surprised Warren, a former bankruptcy professor, didn't instead propose that student loans should be dischargeable in bankruptcy, perhaps even if there was some initial period of nondischargeability. It seems that proposal would be more better received, since she would merely be asking that it be treated similar to other unsecured debts. Any thoughts on why that wouldn't be a more realistic proposal?

[Ken T]

Colin,

My estimation is that she wants college to be largely free - going forwards and backwards. I think she realizes that it would be unfair to make college free for most 18 years olds while burdening 22 year olds with a 7 year wait to discharge their student loans IF they choose to accept the (unfair) stigma of filing a bankruptcy.

Her proposal will provide much needed debt relief to a much larger group of people then returning to earlier bankruptcy legislation would do; I think her being a former bankruptcy professor is why she realizes how flawed and insubstantial just rolling the bankruptcy laws back on student loans would be.

[FJP]

I think Senator Warren would be in favor of dischargeability after some period of good faith efforts to repay. She is showcasing forgiveness in her campaign because unlike dischargeability, forgiveness would front-load the economic benefits. And it's a better sell to voters to say "I have a way to keep student loan debt from bankrupting you" than to say "I have a proposal to help you if your student loan debt is so crushing it drives you into bankruptcy."

[LTK]

Why do you consider increased housing prices to be a good thing? They're the same houses, so in aggregate no one is better or worse off. You're just saying that in addition to directly taking money from people who didn't borrow heavily for school and giving it to to people who did, this plan indirectly takes money from non-homeowners and gives it to homeowners. I agree, but nothing in that implies this creates real value in aggregate. Even if you think that fiscal stimulus would be positive-sum, that doesn't explain why student loan debtors are the best recipients--you could just as easily extend the EITC, or spend more on Medicaid, or any number of pet causes.

Warren's plan has been criticized for favoring a lower tier of the elite over the people in greatest need--people who didn't go to college at all, or who attended a community college paid entirely by Pell Grants. It seems like you're arguing here that to a second order, it actually does that even more.

[Greg Taylor]

Warren proposed a bill that would allow student debt to be forgiven in bankruptcy late last week. Flat out debt forgiveness may not be politically viable at this time. Unfortunately, our BK system is far too expensive ($ costs plus stigma) and lacks the capacity to deal with tens of millions who've defaulted on student loans.

Forgiving the interest and fees on student debt might be a politically viable first step. As incentive to pay the principle, student loan-related dings on credit records would be cleaned when the principle was paid.

[FJP]

@ Greg Taylor -- I agree with you in theory, but the current system is set up the opposite way, to favor negative amortization over principal reduction. I'm wondering how one would design a workable system where some borrowers pay interest and others get in effect an interest free loan.

It might make more sense just to allow forgiveness for anyone after 8 straight years of negative am under IBR, or at social security retirement age after a even shorter time of negative am. The time periods are open to discussion. The basic concepts are: (i) there is some period of continuous negative am after which it is reasonable to expect the borrower's income will not suddenly improve, and (ii) it's nothing but cruelty to keep seniors on a negative am treadmill when there is no realistic home of any principal repayment.

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