Historic Mortgage Drawdown
We need to estimate the level of new mortgages drawn down over time. If residential mortgages were rising very rapidly (and this is usually the case when real estate bubbles develop) a reasonable first approximation is to take the net increase in mortgage loans and assume that it is close to the gross increase. This may be done at the system level or for individual banks. Some countries actually publish gross drawdowns and these should be used when available.
Next we estimate how much of these loans have been repaid. Based on our example of a 20-year mortgage we know approximately how much capital is repaid in each year.
We are only interested in the loans made in 1995, 1996 and 1997. These are the only loans that are at risk of being “under water”. A mortgage taken out in 1995 is approximately six years old and hence approximately 17% of the original principal has been repaid. This could be done on a quarter by quarter basis but besides from adding complexity and increasing the risk of computational error it does little to increase the accuracy of the estimates.
We then calculate the estimated balance outstanding and subtract it from the current estimated value of the properties bought. This shows that the only properties at risk were those bought between 1Q96 and 4Q96.
Finally, we can make a reasonable first-cut estimate of the level of negative equity. Approximately 12% of mortgage loans, by value, have negative equity with the level of negative equity highest for people who bought in 3Q96 at approximately 30% of their outstanding balance.
Part of the reason for including this example is to illustrate how in an imperfect world, where the data to arrive at a definitive answer either does not exist or is not reported, it is still possible with many problems to make some reasonable quantified conclusions using the data that is available, some clear approximations and a bit of creativity.
This method of estimating the level of mortgages with negative equity will not work in markets with significant levels of mortgage securitization.