July 2017 Loan Application Defect Index

Seven-Month Loan Defect Risk Trend Takes a Break

"Rising rates may reduce overall mortgage affordability and incent borrowers to consider adjustable-rate mortgages, but the product shift isn't likely to impact defect, fraud and misrepresentation risk," says Chief Economist Mark Fleming.

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

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained the same in July 2017 as compared with the previous month.
  • Compared to July 2016, the Defect Index increased by 20.0 percent.
  • The Defect Index is down 17.6 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions increased 1.4 percent month-over-month, and is 20.3 percent higher than a year ago.
  • The Defect Index for purchase transactions remained the same compared to last month, and is up 15.2 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. South Dakota (+68.5%)
  2. North Dakota (+54.5%)
  3. Wyoming (+50.8%)
  4. North Carolina (+39.4%)
  5. Iowa (+33.9%)

There is no state with a year-over-year decrease in defect frequency.

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

  1. Raleigh, NC (+54.0%)
  2. New Orleans (+34.7%)
  3. Charlotte, NC (+28.6%)
  4. Buffalo, NY (+27.6%)
  5. Tampa, FL (+25.3%)

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

  1. Houston (-1.1%)

"Finally, after seven consecutive months of increasing defect, fraud, and misrepresentation risk, no change compared to last month is welcome news," said Mark Fleming, chief economist at First American. "In particular, purchase transactions, which are inherently more at risk of defects, fraud and misrepresentation, showed no increase compared to a month ago. One month doesn't establish a trend, so it will be important to see if we've reached a turning point in the long-run trend of increasing defect risk."

Will The Fed's Actions in September Increase Loan Defect Risk?

  • In September, the Federal Open Market Committee (FOMC) may act again to push interest rates higher. Historically, when mortgage rates increase, more borrowers consider adjustable-rate mortgages with lower rates instead of more traditional fixed-rate mortgages to maintain purchasing power.
  • Analysis of defect, fraud and misrepresentation risk trends for adjustable- and fixed-rate mortgages shows that, prior to this year, adjustable-rate mortgages have been riskier, sometimes significantly.
  • In 2017, while risk has been increasing for both loan types, fixed-rate mortgage risk has closed the gap. Currently, the defect risk for both adjustable- and fixed-rate mortgages is approximately the same.
  • Rising rates may reduce overall mortgage affordability and incent borrowers to consider adjustable rate mortgages, but the product shift isn't likely to impact defect, fraud and misrepresentation risk.
Chart: Current Defect Index Values

"An adjustable-rate mortgage can be a good alternative to a fixed-rate mortgage in a rising rate environment, but they have historically had more fraud and misrepresentation risk," said Fleming. "Yet, this year the risk gap has closed. Rates may rise and adjustable-rate mortgages may be more attractive, but the Fed's actions won't impact loan defect risk."

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.