Student Loan Debt Bomb Threatens U.S. Housing Market

NEW YORK ( MainStreet) -- The housing crisis of recent years has made Americans more determined than ever to cut their mortgage debt, and a report from the Federal Reserve Bank of New York says they're doing a good job of it.

Despite this good news though, there is what could be a ticking time bomb on the horizon: The next generation of college students struggling to stay above water on their student loan obligations.
Student loan debt is set to blow a hole in the housing market and U.S. economy in general, a Fed study says.

According to the Federal Reserve, total student loan debt in the U.S. ticked up in the fourth quarter of 2011 to $867 billion. A white paper released by the Federal Reserve Board to Congress on Jan. 4 suggests that any trouble with growing student loan debt is like a loaded shotgun to the U.S. economy.

In it the study authors note that excessive debt among young Americans has a profoundly negative effect on the U.S. housing market, and on the economy in general, since it is those very young people who typically are first-time buyers for modestly sized homes.

The paper notes that from 2009 through 2011, just 9% of 29- to 34-year-olds were approved for a first-time mortgage. Not coincidentally, that age group is at the front of the line for those drowning in debt from student loans (especially graduate school students and those who have left graduate school), fueled by the apparently unstoppable increase in tution fees at schools around the country.

The Fed paper adds that banks are only lending to "qualified" borrowers, and would-be homeowners with excessive student loan debt aren't high on their approval list. That leaves younger consumers locked out of the mortgage market and forces them into rentals, which takes away a historic linchpin of the entry-level housing market.

That, in turn, reduces demand for "starter homes" and leaves homeowners who want to move on and buy bigger, more expensive homes to house their growing families in a bind -- they want to sell their starter homes, but with young consumers boxed out, fewer people are able to buy them.

That's all a roundabout way of saying higher student loan debt is a warning sign not just for the credit health of college grads, but for the economy as a whole as well.

With the average student loan debt burden standing at $25,000 and rising, according to the National Association of Consumer Bankruptcy Attorneys, we're not actually all that far off from that student loan debt bomb. The NACBA reports that the student loan debt landscape is darkening -- and fast:
  • More than four out of five bankruptcy attorneys (81%) say that potential clients with student loan debt have increased "significantly" or "somewhat" in the past three to four years. Overall, about half (48%) of bankruptcy attorneys reported significant increases in such potential clients.
  • Nearly two out of five of bankruptcy attorneys (39%) have seen potential student loan client cases jump 25% to 50% in the past three to four years. An additional quarter (23%) of bankruptcy attorneys have seen such cases jump by 50% to more than 100%.
  • Most bankruptcy attorneys (95%) report that few student loan debtors are seen as having any chance of getting a discharge as a result of undue hardship.

It seems that if the student debt bomb does detonate, don't be surprised if it takes a good chunk of the housing market down with it.

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