The U.S. boom in nonprime mortgage lending between 2004 and 2006 was quickly followed by a swift rise in delinquencies and defaults on the loans. Evidence from the current downturn suggests that reductions in borrower equity are major contributors to delinquencies and defaults. Accordingly, policymakers with their eyes on the foreclosure crisis are crafting policies that rely to some extent on measures of negative equity, in which the value of a property is below the mortgage balance.

A new study of the nonprime mortgage market supports earlier findings on the relationship between negative equity— which is affected by the time and place of mortgage origination and the existence of subordinate liens on the property—and default (“Below the Line: Estimates of Negative Equity among Nonprime Mortgage Borrowers,” Economic Policy Review, forthcoming).

Authors Andrew F. Haughwout and Ebiere Okah estimate negative equity as of December 2008, describe the sources of negative equity, and summarize the characteristics of borrowers below the equity line. Combining information from house price indexes with data on individual loans, the authors gauge the prevalence and magnitude of negative equity across a range of dimensions, such as the location of the property and the year the mortgage originated.

The study finds that nonprime borrowers who are “below the line” share several traits. These borrowers took out loans near the housing market peak and had mortgages with high loan-to-value ratios, usually achieved with subordinate liens. The authors also find that borrowers with a mortgage exceeding the value of their house are twice as likely as positive equity borrowers to be seriously delinquent on their first-lien mortgage.

Haughwout and Okah show that while negative equity loans exist in most U.S. metro areas, they are disproportionately concentrated in housing markets that experienced especially large swings in house price appreciation, particularly in California. They estimate that three California metro areas account for more than a quarter of the negative equity mortgages in their sample. Moreover, “because of the higher balances on these mortgages, the loans account for nearly half of the overall difference between house values and mortgage balances.”

In addition, the authors use information from housing price futures contracts to estimate the path of negative equity beyond 2009. Their results suggest that if house prices fall an additional 10 percent from December 2008 levels, “approximately 1.5 million new nonprime borrowers would see their house value fall below their current mortgage balance” and the aggregate value of negative equity among ­nonprime borrowers could reach $135 billion.