January 2017 Loan Application Defect Index

Defect, Fraud and Misrepresentation Risk Accelerates as Market Composition Shifts to Riskier Purchase Transactions

"In real estate, location matters. In defect, misrepresentation and fraud risk, loan purpose matters," says Chief Economist Mark Fleming.

The First American Loan Application Defect Index showed that in January 2017:

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased 5.8 percent in January 2017 as compared with the previous month.
  • Compared to January 2016, the Defect Index decreased by 3.9 percent.
  • The Defect Index is down 28.4 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions increased 3.5 percent month-over-month, and is 9.2 percent lower than a year ago.
  • The Defect Index for purchase transactions increased 2.5 percent compared to last month, and is down 1.2 percent compared to a year ago.

States with the highest year-over-year increase in defect frequency:

  1. Wyoming (+32.2%)
  2. North Dakota (+29.0%)
  3. Montana (+27.3%)
  4. Mississippi (+25.4%)
  5. Louisiana (+20.3%)

States with the highest year-over-year decrease in defect frequency:

  1. Michigan (-14.3%)
  2. Connecticut (-11.5%)
  3. California (-10.8%)
  4. Rhode Island (-10.1%)
  5. South Carolina (-10.0%)

Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with a year-over-year increase in defect frequency:

  1. Raleigh, NC (+20.9%)
  2. St. Louis (+14.5%)
  3. Birmingham, AL (+7.4%)
  4. Minneapolis (+5.5%)
  5. Jacksonville, FL (+4.7%)

Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the highest year-over-year decrease in defect frequency:

  1. Louisville/Jefferson, KY (-20.7%)
  2. Detroit (-20.0%)
  3. Oklahoma City (-17.4%)
  4. Sacramento, CA (-15.8%)
  5. Miami (-15.3%)

"This month, the Loan Application Defect Index continued the upward trend that started in December 2016. The overall index increase is largely the result of waning refinance activity in the mortgage market," said Mark Fleming, chief economist at First American. "Defect, misrepresentation and fraud risk is significantly lower on refinance transactions, so the increased risk of misrepresentation and fraud is due to the increasing share of higher risk purchase transactions within the mortgage market."

In Defect and Misrepresentation Risk, Purpose Matters

  • The Mortgage Bankers Association reported at the end of January that the share of refinance applications fell below 50 percent for the first time since July 2015.
  • The last time the Loan Application Defect Index experienced a significant increase was also in mid-2015 in response to the decreasing share of refinance transactions in the market at the time.
  • The market composition of purchase and refinance activity matters because our analysis consistently finds refinance transactions to be less risky. Currently, refinance transactions have 30 percent less loan application defect, misrepresentation and fraud risk than purchase transactions.
  • The loan purpose risk gap, which measures the difference in risk between refinance and purchase loan transactions, has been increasing since October 2014 when the difference was only 4 percent.

"While technology adoption has reduced risk for both purchase and refinance transactions, part of the overall decline in risk has been due to the recent dominance of refinance activity relative to purchase activity," said Fleming. "As the mortgage market composition continues to shift toward purchase transactions in 2017, the risk of defect, fraud and misrepresentation will also increase. In real estate, location matters. In defect, misrepresentation and fraud risk, loan purpose matters."

Methodology

The First American Loan Application Defect Index estimates the level of defects detected in the information submitted in mortgage loan applications processed by the First American FraudGuard® system. The index is based on the frequency with which defect indicators are identified. The Defect Index moves higher as greater numbers of defect indicators are identified. An increase in the index indicates a rising level of loan application defects. The index, nationally and in all markets, is benchmarked to a value of 100 in January 2011. Therefore, all index values can be interpreted as the percentage change in defect frequency relative to the defect frequency identified nationally in January 2011.

About First American

First American Financial Corporation (NYSE: FAF) is a leading provider of title insurance, settlement services and risk solutions for real estate transactions that traces its heritage back to 1889. First American also provides title plant management services; title and other real property records and images; valuation products and services; home warranty products; property and casualty insurance; and banking, trust and investment advisory services. With revenues of $5.6 billion in 2016, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2016, First American was recognized by Fortune® magazine as one of the 100 best companies to work for in America. More information about the company can be found at www.firstam.com.

Opinions, estimates, forecasts and other views contained in this page are those of First American's Chief Economist, do not necessarily represent the views of First American or its management, should not be construed as indicating First American's business prospects or expected results, and are subject to change without notice. Although the First American Economics team attempts to provide reliable, useful information, it does not guarantee that the information is accurate, current or suitable for any particular purpose. © 2017 by First American. Information from this page may be used with proper attribution.