The Impact of Early-Life Debt on the Homeownership Rates of Young Households: An Empirical Investigation

There is growing concern that the rising tuition and educational debt burdens of college students, as well as increased credit card usage, will adversely impact young households. One important post-college decision that may be affected is when to purchase a home. There is a literature that documents the impacts of educational debt on college attainment, growing research on credit card debt, and a separate literature that examines the homeownership decisions of young adults. There has not yet been an analysis of the impacts of these early life debts on homeownership rates. Analysis of data from the Survey of Consumer Finances indicates that in 2003 educational debt was associated with reduced homeownership rates. In addition, credit card debt was also associated with homeownership rates, although its effect was positive, offsetting the influence of educational debt. Credit constraints on young adults do not appear to explain the homeownership gap. Introduction In recent years, rising costs of higher education and the increased debt burden of students have received much attention. There is growing concern that students are being overwhelmed with debt in order to finance their higher education. According to some sources debt burdens are still growing and some undergraduates are leaving school with an average of $40,000 of educational debt. In addition to the mounting debt burden itself, there is also concern that young adults do not fully understand how to manage their debt or the consequences of failing to do so. Amid all of this distress, however, there has not yet been a precise analysis of whether debt accrued during college and young adulthood is having a meaningful impact on post-college decisions. While a considerable amount has been written concerning the efficacy of loans and financial aid in promoting higher education, there is very little in the economics literature that examines the post-schooling impact of debt for education. One important post-school decision is when to purchase a home. Certainly, this decision is influenced by many factors, not the least of which is the household's budget constraint. It is apparent that educational debt will reduce initial wealth and payments on such debt will tighten the household's budget constraint. In addition, ∗ Ph.D. Candidate, Department of Economics, The Ohio State University. Email: shand.2@osu.edu. I thank my advisor Professor Lucia Dunn for all of her suggestions and guidance. I also thank Professor Cosslett, Professor Logan and Professor Weinburg for their helpful comments and advice. Thank you for comments received by participants at the Midwest and Eastern Economics Associations meetings. All errors are my own. 1 USAToday, 2006. 2 Newsweek, 2006. 1 educational debt, as well as other types of debt such as credit card debt, may function as a signal in various markets. Holding debt gives someone a credit history, which is informative to lenders about repayment habits and the potential for bankruptcy. Debt, be it from educational loans or associated with credit cards, may potentially impact the homeownership decision in two distinct ways. The presence of debt in a household’s wealth portfolio may render the household unable to obtain a mortgage for the amount or terms desired for a home purchase, in which case the household may be considered credit constrained. In addition, the presence of debts in the budget constraint may induce the household to voluntarily forgo or delay home purchase until debts are paid down. The goal of this paper is to incorporate the existence of early-life debt, particularly educational loans, as well as credit card debt, into the analysis of the homeownership decision of young households. While there are already rich bodies of literature in economics examining tenure choice and the wealth profiles of young people, as well as a growing body of literature on credit card usage, this is the first work, to our knowledge, to attempt to explicitly quantify the impact of educational loans and early life credit card debt on homeownership. This paper presents a theoretical model that describes why households may delay home purchase due to their debts. We present reduced form estimates of the propensities for homeownership among young households as a function of only household attributes, both controlling and not controlling for the possible impact of credit constraints, using the Survey of Consumer Finances from 1992 to 2004. Educational debt has had a large negative impact on homeownership rates in recent years. Credit card debt, on the other hand, has had a positive effect for the same period and partially offsets the influence of educational debt. The results provide support for the recent concern over early-life debt, particularly from educational loans. However, the concern over credit card debt may be overstated. The remainder of the paper is organized as follows: Section 1 gives a review of previous literature; Section 2 discusses the theoretical model. Section 3 discusses the methodology. Section 4 discusses the data and variables while section 5 contains the results. Section 6 discusses how much of the gap in homeownership between debtor and non-debtor households may be attributed to credit constraints. Finally, section 7 concludes.