March 2016 Loan Application Defect Index

Loan Application Defect and Fraud Risk Emerging in Southern States

"In addition to Texas and Florida, Oklahoma and South Carolina are emerging risky states," says Chief Economist Mark Fleming.

The First American Loan Application Defect Index, which estimates the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications, increased 1.3 percent in March as compared with February and decreased by 2.6 percent as compared with March 2015. The Defect Index, which reflects estimated mortgage loan defect rates over time, by geography and by loan type, is down 25.5 percent from the high point of risk in October 2013.

The Defect Index increased modestly this month for the first time since July 2015, ending seven consecutive months of declining defect and misrepresentation risk. While February 2016 is now the new low point for the index, it's too early to know if the increase in misrepresentation and fraud risk in March is the beginning of a long-term upward trend or a short-term adjustment. One possibility for the reversal of direction is the month-over-month increase in risk among Federal Housing Administration (FHA), Veterans Administration, and United States Department of Agriculture loans.

The defect risk for these loan transaction types increased 1.4 percent from February to March, as opposed to conventional loans that had no change month-over-month. The share of FHA mortgage originations increased after a reduction in the premium last year, making them relatively more competitive for borrowers with low down payments and low credit scores, which also typically have higher defect risk.

The Defect Index for refinance transactions increased 1.5 percent month-over-month, but remains 5.7 percent lower than a year ago. The Defect Index for purchase transactions increased 1.2 percent month-over-month, but remains down 3.4 percent compared to a year ago. Since defect risk for both purchase and refinance transactions peaked in late 2013, defect risk on refinance transactions has declined more than defect risk for purchase transactions, declining 33.0 percent as compared to 19.2 percent for purchase transactions.

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

  1. North Dakota (+19.6%)
  2. Kentucky (+15.9%)
  3. Utah (+14.1%)
  4. Missouri (+13.4%)
  5. District of Columbia (+9.2%)

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

  1. Michigan (-15.5%)
  2. West Virginia (-12.5%)
  3. Alabama (-11.8%)
  4. New Mexico (-10.4%)
  5. Oregon (-7.9%)
  6. Mississippi (-7.9%)

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

  1. Louisville, KY (+23.1%)
  2. Salt Lake City (+17.6%)
  3. Houston (+16.3%)
  4. St. Louis (+14.9%)
  5. Memphis, TN (+9.1%)

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

  1. Detroit (-19.4%)
  2. Birmingham, AL (-14.4%)
  3. Jacksonville, FL (-13.5%)
  4. Hartford, CT (-8.8%)
  5. Columbus, OH (-8.5%)

"While loan application and mortgage risk increased modestly this month, risk remains significantly lower than a year ago and is significantly lower than it's been in the last five years," said Mark Fleming, chief economist at First American. "Improved loan manufacturing compliance, underwriting consistency and risk management are finally paying off for the industry with less defect, misrepresentation and fraud risk."

Emerging Risk in the South

Last month, we focused on Texas and Florida as high risk areas of the country. Florida is risky because of the high concentration of condominiums that are popular among investor and foreign buyers in big markets, like Miami. Texas is experiencing the impact of challenges in the energy market spilling over into the real estate market. However, there are two other emerging-risk markets also in the South — Oklahoma and South Carolina.

The energy sector is not the only one suffering from international market dynamics driving prices down. The agricultural sector also faces challenges. Agricultural commodities, such as corn, rice, cotton and wheat, have all suffered significant price declines in the last few years. As in the energy sector, slowing global economic growth has triggered a decline in demand for agricultural commodities relative to supply. In addition, strong demand for U.S. bonds has increased the strength of the U.S. dollar and made agricultural exports more expensive abroad.

As a result, misrepresentation and fraud risk are increasing in Oklahoma, whose economy relies heavily on both the agriculture and energy sectors, and in South Carolina, with its heavy reliance on agriculture. Misrepresentation and fraud risk is up 8.4 percent and 7.4 percent respectively year-over-year. Tulsa, Okla. and Charleston, South Carolina have seen misrepresentation and fraud risk increase by more that 10 percent year-over-year.

"The cliché, 'It's the economy stupid,' still holds true today, although it may be better applied locally. Southern-state economies face the challenges presented by falling prices in energy and agricultural commodity markets," said Fleming. "Economic distress increases the incentive for loan application misrepresentation, if not necessarily outright loan application fraud. In addition to Texas and Florida, Oklahoma and South Carolina are emerging risky states."


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

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.