Investors, beware: The stock market is at a high-risk juncture and a credit event could be just around the corner. One more risk – and potential trigger – that’s looming is the restart of student loan repayments.
Student loan payments resume ➡️ Less spending on travel and AirBnB type rentals ➡️ Overleveraged 2nd, 3rd, and 4th home owners see big drop in rental income ➡️ Homes listed for sale ➡️ Inventory problem for housing solved and prices break down.
— Michael A. Gayed, CFA (@leadlagreport) June 14, 2023
The “butterfly effect” is the idea in chaos theory that a small change can trigger a series of larger changes.
When it comes to the housing market, the butterfly effect goes like this: As student loan payments resume, individuals may have less disposable income for discretionary spending, including travel and rentals. This could lead to a decrease in income for owners of second, third, and fourth homes who rely on rental income. As a result, these property owners may be compelled to sell, potentially solving the inventory problem plaguing the housing market and causing prices to decline.
It’s not as farfetched as it seems when I first floated the idea on X in mid-June.
How Student Loan Repayment Trickles Down to Housing
Student loan debt has been on a vertical trajectory for some time now. As it stands, it’s the second-largest consumer debt category (mortgages are the first). The total amount of student loan debt is nearing an astounding $1.8 trillion. Borrowing has become a necessity for many who pursue higher education.
During Covid-19, the Department of Education instituted an automatic pause on federal student loan payments in 2020. During this pause, interest on these loans was suspended, providing much-needed financial relief for borrowers. This policy has been extended multiple times, affording borrowers over three years of relief from loan payments. This pause is set to end in October 2023, reintroducing a significant financial burden to millions of individuals.
The resumption of student loan payments could have a domino effect on the housing market. As borrowers grapple with this reintroduced financial obligation, they might need to cut back on discretionary spending. This could lead to less spending on travel and rentals, potentially impacting homeowners who rely on rental income from properties listed on platforms like Airbnb.
This decrease in rental income could strain homeowners, particularly those who own multiple properties. They might be forced to sell their additional properties. In turn, this could increase the inventory of homes available for sale. An increase in housing inventory could alleviate some of the current housing market pressures, possibly leading to a decrease in home prices.
The potential for an increase in housing inventory due to the resumption of student loan payments comes at a time when the housing market is already strained.
Brace Yourself for a Housing Market Crash
Over the past few years, the housing market has faced limited inventory and skyrocketing prices. The median home price in the U.S. has seen a significant increase, making homeownership increasingly unattainable for many. If the resumption of student loan payments leads to an increase in housing inventory and a decrease in home prices, it could potentially make homeownership more attainable for some. However, for those grappling with student loan debt, the prospect of homeownership might still be out of reach.
For borrowers, the resumption of student loan payments means that a significant portion of their income will once again go toward debt repayment. The average student debt payment is substantial, with borrowers paying hundreds of dollars per month. Down payment? Good luck. With the resumption of student loan payments, many borrowers might find their debt-to-income ratios negatively impacted.
This could hinder their ability to qualify for a mortgage, further complicating their path to homeownership.
I think that student loan repayments could be the very catalyst the housing market needs to break. And if I’m right, that’s a long cycle that will take time to play out.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.