Almost half of US property owners could face negative equity by 2011

Falling residential property prices in the US will plunge millions of more home owners into negative equity by 2011, according to a new report from Deutsche Bank.

It has published figures which show that around 14 million property owners were in negative equity in the first quarter of this year and predicts that will rise to 25 million by the first quarter of 2011, some 48% of all mortgage holders in the US.

While subprime and option adjustable-rate mortgages are the biggest source of underwater borrowers in the current property market, Deutsche said a larger percentage of prime conforming and prime jumbo borrowers will also end up with negative equity.

Prime conforming and prime jumbo will make up 79% of all US mortgages and Deutsche estimates 41% of conforming and 47% of jumbo will be underwater, up from current levels of 16% and 29%, respectively.

This rapid influx of underwater borrowers will have a significant impact on default rates, the bank claims in a report. In addition to future underwater borrowers being forced into default from a major life event such as unemployment, divorce, or disability, Deutsche warned others may 'ruthlessly' or strategically default.

Increased defaults in the middle class will suppress consumption, added Deutsche, further slowing housing recovery.

Analysts point out that the current housing recession is unique in that it was brought on and perpetuated by a number of factors including unstable loan products, crashing housing prices, and unemployment.

Borrowers with loan products with already high underwater rates will only get worse, the report also says. By 2011, Deutsche predicts 89% of option ARM borrowers will be underwater, up from 77% in 2009. The rate of underwater subprime borrowers will increase from 50% to 69%, and underwater Alt-A borrowers will increase from 49% to 66%.

How much negative equity a borrower faces depends on the type of loan they have. For prime conforming borrowers, Deutsche predicts the number of borrowers with negative equity between 105% and 125% will virtually equal the number of borrowers with what it calls 'severe negative equity' of over 125%.

But Deutsche expects the 89% of option ARM borrowers underwater to be split with most, some 77%, holding severe negative equity. The split for underwater Alt-A borrowers is expected to take an opposite proportion, with 49% of all Alt-A borrowers in negative equity and only 18% in severe negative equity. Underwater subprime borrowers will face a similar breakdown, the report concludes.