November 2016 Loan Application Defect Index

Automation of Verification Tools to Drive Risk Improvements in 2017

"The Day 1 Certainty initiative at Fannie Mae and incorporation of similar automated verification tools at Freddie Mac are likely to have a significant positive impact on mortgage loan application defect and misrepresentation risk in the next year," says Chief Economist Mark Fleming

The First American Loan Application Defect Index showed that in November 2016:

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications, remained unchanged in November as compared with October.
  • Compared to November 2015, the Defect Index decreased by 12.8 percent.
  • The Defect Index is down 33.3 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions decreased 3.4 percent month-over-month, and is 16.4 percent lower than a year ago.
  • The Defect Index for purchase transactions is unchanged compared to last month, and is down 5.9 percent compared to a year ago.

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

  1. Maine (+35.4%)
  2. South Dakota (+18.0%)
  3. Montana (+17.4%)
  4. Vermont (+13.9%)
  5. Wyoming (+12.9%)

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

  1. Michigan (-20.5%)
  2. California (-19.7%)
  3. Oklahoma (-17.2%)
  4. New Mexico (-17.1%)
  5. Florida (-17.0%)

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

  1. St. Louis (+4.2%)

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 (-29.3%)
  2. Detroit (-26.0%)
  3. Oklahoma City (-25.8%)
  4. Sacramento, CA (-25.3%)
  5. Miami (-23.3%)

"The long and consistent downward trend in loan application defect and misrepresentation risk paused this month, after falling in seven of the last eight months. Yet, I expect the risk trend to continue its downward trajectory in 2017," said Mark Fleming, chief economist at First American. "The Day 1 Certainty initiative at Fannie Mae and incorporation of similar automated verification tools at Freddie Mac are likely to have a significant positive impact on mortgage loan application defect and misrepresentation risk in the next year."

ARMs Race

"Next year is expected to be a transition year for loan application defect, misrepresentation and fraud risk. Rising rates in the market will drive a transition to more purchases relative to refinances and more ARMs relative to fixed-rate loans," said Mark Fleming, chief economist at First American. "All other factors being equal, both of these trends point to increased defect, misrepresentation and fraud risk."

  • In a rising mortgage-rate environment, such as what we have experienced since the election, the incentive to choose an adjustable rate mortgage (ARM) over the much more popular fixed-rate mortgage increases.
  • In a recent Mortgage Bankers Association weekly application survey, the share of ARM applications increased and the rate on an ARM actually declined modestly.
  • Currently, according to our defect index, ARMs are about 6 percent riskier than fixed-rate mortgages.
  • The gap in defect, misrepresentation and fraud risk between ARMs and fixed-rate mortgages has narrowed in the last year, as ARM risk declined 11 percent year-over-year, while fixed-rate mortgage risk has declined at a slower rate of 7.7 percent year-over-year.

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 $5.2 billion in 2015, the company offers its products and services directly and through its agents throughout the United States and abroad. 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. © 2016 by First American. Information from this page may be used with proper attribution.