February 2017 Loan Application Defect Index

Defect, Fraud and Misrepresentation Risk Surges Higher as Mortgage Rates Rise

"Increased share of higher risk purchase transactions and the potential for more adjustable rate mortgages amid the expected strong spring market means mortgage lenders should remain watchful for defect and fraud risk," says Chief Economist Mark Fleming.

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

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased 4.1 percent in February 2017 as compared with the previous month.
  • Compared to February 2016, the Defect Index increased by 1.3 percent.
  • The Defect Index is down 25.5 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions increased 3.4 percent month-over-month, and is 6.2 percent lower than a year ago.
  • The Defect Index for purchase transactions increased 2.4 percent compared to last month, and is up 2.4 percent compared to a year ago.

Mark Explains the Loan Application Defect Index

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

  1. Wyoming (+43.1%)
  2. North Dakota (+38.2%)
  3. Mississippi (+31.8%)
  4. South Dakota (+31.5%)
  5. Montana (+26.5%)

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

  1. Michigan (-9.6%)
  2. Connecticut (-9.0%)
  3. New York (-7.4%)
  4. Maryland (-5.4%)
  5. California (-5.4%)

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

  1. Raleigh, NC (+27.7%)
  2. Birmingham, AL (+11.4%)
  3. St. Louis (+11.3%)
  4. Minneapolis (+11.1%)
  5. Jacksonville, FL (+9.6%)

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

  1. Detroit (-16.9%)
  2. Louisville/Jefferson, KY (-14.8%)
  3. Milwaukee (-14.1%)
  4. Austin, TX (-12.0%)
  5. Oklahoma City (-11.8%)

"This month, the Loan Application Defect Index surged higher as rising mortgage rates continue to put downward pressure on lower risk mortgage refinance activity. The March rate increase by the Federal Open Market Committee and strong economic performance will continue to pressure rates upward," said Mark Fleming, chief economist at First American. "As the spring home buying season gets underway in earnest, the volume of higher risk purchase applications will grow and further increase loan application defect and fraud risk. The increased share of higher risk purchase transactions and the potential for more adjustable rate mortgages amid the expected strong spring market means mortgage lenders should remain watchful for defect and fraud risk."

Rising Rates Spurs Demand for Historically Riskier Loan Productss

  • The average rate for a 30-year, fixed-rate mortgage was 4.15 percent in February, which continued to put downward pressure on the volume of lower risk mortgage refinances.
  • As mortgage rates increase, some borrowers will seek affordability by switching from 30-year, fixed-rate mortgages to less expensive adjustable rate mortgages (ARMs).
  • The 5/1 ARM averaged 3.2 percent in February, almost a full percentage point less than the traditional fixed-rate mortgage.
  • According to the Mortgage Bankers Association Application survey, the share of ARM applications reached its highest level in over a year at 7.5 percent of total applications.
  • Over the last three months, loan application, defect and fraud risk has increased by 5.6 percent on ARM loan applications.
  • While there is no significant difference in risk between ARMs and fixed-rate mortgages today, historically ARM loan applications have been the riskier loan product type.

"Defect, fraud and misrepresentation risk continues to respond to the shift in market composition. Rising mortgage rates continue to increase the share of higher risk purchase loan applications, but they are also incenting more borrowers to apply for ARMs. The savings for the consumer can be significant, but ARM loan applications have historically had higher defect, misrepresentation and fraud risk," said Fleming. "The increasing popularity of adjustable rate mortgages is something to keep an eye on as the spring home buying season warms up."

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.