Borrowers who pay off a student loan before their payment period is over are more likely to purchase a home in the year following their payoff than those who pay off their loans according to their scheduled repayment plan, which is likely due to jumps in wealth or income, according to a recent report from the Consumer Financial Protection Bureau (CFPB).
The report, which analyzed the repayment and credit trends of 270,000 students who payed off at least one student loan before their payment period was over between January 2013 and October 2017, aimed to determine why students pay off their loans when they do, and what implications that has on their willingness to take on more debt, such as a mortgage. The CFPB found that most borrowers (94 percent) pay off at least one student loan before the end of their repayment period with one large payment — which was on average 55 times larger than a borrower’s prior monthly payments.
The CFPB discovered that when borrowers make one final payment on a student loan, they also often take steps to speed up the repayment process on their remaining student loans. The report found that after borrowers paid off one loan, they increased their monthly payments on remaining loans by an average of 25 percent. In addition, the report found in the months leading up to and the month of a loan payoff, these students also reduce their credit card balances. During this time, the CFPB discovered that the borrowers’ average credit card balance dropped by six percent, from $5,977 to $5,628.
In addition to increasing remaining loan payments and reducing credit card balances, the CFPB found that borrowers who pay off one loan early are 31 percent more likely to take out a mortgage on a home in the year following the payoff than the year before the payoff. However, for the remaining 6 percent of borrowers who pay off their loans according to their scheduled plans, the CFPB found no clear evidence of an increase or decrease in taking out mortgages in the months before and after repayment is complete. It did find however, that these borrowers took steps to increase payments on other student loans similar to those who did pay off their loans early.
While the CFPB wrote that there is a clear connection between loan payoff and the willingness to take on more debt, it debated the cause for this discrepancy in the report.
“On the one hand, because credit card debt falls prior to the student loan payoff, jumps in wealth or income or life events like household formation (which are not observable in the data) are consistent with all of the changes,” the CFPB wrote. “On the other hand, borrowers could be using their savings to pay down debts in anticipation of purchasing a home. They could pay off debts early because of their concerns over underwriting requirements, such as limits on monthly payment-to-income ratios, or their aversion to holding multiple large debts.”
The CFPB concluded, however, that students’ savings are most likely not the primary factor in this trend because while it found that credit card balances decrease immediately prior to and during the month of a loan payoff, they return to their normal levels shortly afterward, while the “cumulative effects on mortgage take-up steadily increase.” This suggests, according to the report, that “the balance reduction is not sharply tied to the timing of the mortgage origination.” The report also argues that “if borrowers had substantial prior savings, either more gradual increases in student loan payments above the scheduled payment or the allocation of these funds towards a larger mortgage down payment might be expected instead.”
The report noted that this clear link between student loan repayment and taking on new debt such as buying a home can have implications for policies related to repayment options.
“[P]olicies or products that change repayment terms or balances for one credit product are likely to have spillover effects on others, either enhancing the intended effects (e.g. payment relief, increased credit access) or leading to compensating shifts (e.g. reallocated payments or borrowing),” according to the report. “Analyzing borrowers’ behavior across the full set of liabilities—and ideally assets—can improve our understanding of the underlying mechanisms guiding behavior, and lead to more accurate predictions of the impacts new policies or products will have on consumers and the market at large.”
The CFPB also wrote that while this report focuses on borrowers who paid off their loans, “similar approaches could be applied to the large population of student borrowers struggling with rising balances, delinquency, or default,” and that the results of which could “shed light on how borrowers use other credit products to cope with their student debt, how their access to other credit may be inhibited, and how available repayment plans and other programs change these outcomes.”
Publication Date: 7/9/2018