Milestone Purchases: The Economics of “Adulting”
Part 4/4 of Roadmap: Fintech for a New Generation
co-authored by Robert Li and Francis Wilson
When we make big life-changing decisions, sometimes that comes with incurring big life-changing expenses. Two of the most significant “milestone purchases,” buying a home and pursuing postsecondary education, are out of reach for many young Americans. Yet, things like becoming a homeowner and getting a decent education are seen as essential parts of becoming an adult in our society, not to mention their effect on wealth accrual and income prospects, and without the ability to afford these purchases, many young Americans will be unable to achieve the financial prosperity enjoyed by previous generations. Thankfully, flexible new business models have emerged to bridge the gap.
Tuition ISA: a New Way to Pay
As early as 18 (or younger), many people make their first and possibly most important financial decision of their lifetime: pursuing post-secondary education. The cost of college education is one of two household expense categories that consistently outpaces the growth of inflation (the other is healthcare); the National Center for Education Statistics published data indicating that over the last 30 years, tuition nearly tripled at public universities and doubled at private universities, after adjusting for inflation. According to a poll conducted by Morning Consult, only 46 percent of millennials believe their student debt was worth attending college.
Rising tuition costs and COVID’s disruption of in-person learning are causing high school graduates to seriously consider alternatives to getting a college diploma. In the US, an estimated 2 million students attend trade school every year, seeking training in specialised blue-collar vocations. Surveys suggest a strong latent demand for trade school education: 41% of Americans aged 18–24 years said they would attend a trade school over college for career opportunities and high pay potential. On the other hand, training and certification programs for white-collar professions like software programming and data science are highly popular options now for students who might otherwise have to pony up for an expensive 4-year degree to acquire the same skills. Although trade schools and coding boot camps offer a speedier path to employment, many are non-Title IV institutions and hence do not qualify students for federal aid. A new form of tuition financing, Income Sharing Agreements (ISA), is becoming the solution of choice, led by the pioneering success of coding boot camps like Lambda School. With an ISA, the student pays back a percentage of wages for some term after graduating, as opposed to fixed installments as with a traditional loan; repayments are waived if the student remains unemployed after graduating. This model has since been adapted to other trades: TradeUp is an ISA financier that supports students pursuing a trade school education, as is Avenify but for nursing school. At the same time, companies like Vemo Education and Meratas provide the infrastructure and support that enable traditional 4-year colleges to offer ISA to their student bodies.
Financing a Home Sweet Home
Older millennials are now the most active generation of homebuyers. Among those with savings, 41 percent of Gen Z and 40 percent of younger millennials are saving to buy a home, according to a 2018 survey by Bank of America. Yet, given their high student debt load and thin credit file, many millennials will face challenges trying to finance their dream of buying their first house: “getting a mortgage” and “saving for down payment” are among the most commonly cited pain points on the path to home ownership. Obtaining a traditional mortgage requires time (typical time to close is 47 days), good credit (>620 for a conventional mortgage), and a hefty down payment (unless you are okay with higher interest rates or being required to buy PMI).
Over the past years, a number of innovative business models have emerged to fix the accessibility and affordability problem of buying a home. Rent-to-own, for instance, is an alternative to mortgage financing that accommodates homebuyers with weaker credit scores and removes the need to make a large upfront capital outlay (sometimes a small down payment is needed). In a rent-to-own arrangement, the tenant contributes an amount in each rent payment toward building up equity in the home over time. In addition, upon reaching a certain ownership milestone, the tenant is usually offered the opportunity to purchase the remainder of the home or cash out their accrued equity and move out. While rent-to-own is not a brand new concept, companies like DivvyHomes and Zerodown popularised it by streamlining and standardising a closing process and pricing model. These new ways of pursuing homeownership are considered to be more flexible and less financially onerous than a traditional mortgage. Other startups have emerged to help homebuyers secure their dream home in competitive housing markets by helping them make all-cash offers. For instance, Upequity makes all-cash offers on behalf of qualified customers who are in the process of applying for a mortgage, acting as a backup option in case the mortgage is not approved in time. Flyhomes, a full-service real estate brokerage, underwrites both all-cash offers supported by a short-term bridge loan as well as conventional mortgages. Applying for a mortgage can be intimidating for first-time homebuyers. Mortgage broker Morty offers a tech-enabled white-glove experience that walks users through the entire mortgage process, from pre-approval to closing. With the help of Morty, young homebuyers can increase their chances of being approved for a loan, quickly.
Is Your Credit File Thick Enough?
ISA and Rent-to-Own aside, large milestone expenditures still require taking on a large amount of debt most of the time. In the US, your probability of getting approved for a loan and the cost and terms of said loan is dependent on your credit score, which factors in your credit history. Unfortunately, there are 62 million Americans, many of whom are young people, that have a “thin credit file” meaning they have a limited credit history, if any at all. A thin credit file does not necessarily imply low creditworthiness or a poor ability to pay back (since credit scores ignore factors like income level and net worth). However, having thin credit is often enough to deter conventional lenders, depriving many millennials and Gen Z of financial access. This represents both a forgone revenue stream for incumbents and a major business opportunity for disruptive startups such as ToMo Credit and Petal Credit that use alternative data such as cash flow and bank balance information to underwrite applicants.
Within the bounds of the credit scoring system, we also see opportunities for underbanked young people to start building their credit in creative and effective ways. Kikoff provides a credit-builder via a revolving line of credit specifically suited for this use case. Grow Credit allows its customers to build a credit score from making repeat subscription payments to services such as Netflix and Spotify, while Esusu Rent allows tenants to build a credit history from making their rent payments.
