August 2016 Loan Application Defect Index

Loan Application Defect and Fraud Risk Declines Due to Increased Demand for FHA Loans

"Atlanta and Charlotte, two southern cities experiencing large increases in purchase mortgage loan demand, deserve the spotlight for the dramatic improvements in loan application defect and fraud risk," 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, remained unchanged in August as compared with July and decreased by 14.6 percent as compared with August 2015. The Defect Index, which reflects estimated mortgage loan defect rates over time, by geography and by loan type, is down 31.4 percent from the high point of risk in October 2013.

The Defect Index for refinance transactions is unchanged compared to last month, and is 18.1 percent lower than a year ago. The Defect Index for purchase transactions is flat month-over-month, and is down 10.2 percent compared to a year ago. Since defect risk for both purchase and refinance transactions peaked in late 2013, defect risk on refinance transactions continues to decline much more than defect risk for purchase transactions, declining 41.0 percent as compared to 24.0 percent for purchase transactions.

Based on the newly released American Enterprise Institute and First American National Mortgage Market Index (NMMI), purchase loan demand increased 9.2 percent in the second quarter of 2016 compared to a year ago. Furthermore, the NMMI shows that the share of transactions involving loans backed by the Federal Housing Administration (FHA) has increased over the last year relative to transactions involving conventional loans. While FHA loans are generally considered to have higher credit risk than conventional loans, according to the Defect Index, conventional loan risk is down 14.6 percent over a year ago, compared with a year-over-year decline of 17.7 percent for transactions involving FHA/VA/USDA loans. In addition, transactions involving FHA/VA/USDA loans are currently 14.5 percent less risky than transactions involving conventional loans. In fact, loan application and defect risk on transactions involving FHA/VA/USDA loans has declined more in recent years than the defect risk for conventional mortgages.

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

  1. Maine (+19.2%)
  2. North Dakota (+13.6%)
  3. Missouri (+8.7%)
  4. Montana (+5.3%)
  5. Vermont (+5.1%)

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

  1. Michigan (-29.4%)
  2. Florida (-23.8%)
  3. Arizona (-19.3%)
  4. Oklahoma (-19.1%)
  5. New Mexico (-19.0%)

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

  1. St. Louis (+2.7%)

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

  1. Detroit (-33.9%)
  2. Oklahoma City (-27.8%)
  3. Louisville/Jefferson, KY (-27.1%)
  4. Orlando, FL (-25.8%)
  5. Jacksonville, FL (-24.7%)

"Our collaboration with the American Enterprise Institute on the National Mortgage Market Index allows us to track mortgage production by investor transaction type, and with this new visibility, we have observed an increase in the share of FHA loans in the market," said Mark Fleming, chief economist at First American. "While the share of FHA/VA/USDA loans is up, the loan application defect risk on them is down. This has had a positive impact on overall defect risk in the market and partly explains the large decline in defect risk we have seen in the past year."

The Charms of Southern Living Elevate Risk

As mentioned above, the FHA has increased its market share over the last year, according to analysis we publish in the NMMI. Additionally, in that report, we identified Atlanta and Charlotte as two of the fastest growing markets in terms of demand for purchase loans generally, as well as large increases in FHA purchase loans specifically.

In Atlanta, the year-over-year growth rate for purchase loans accelerated almost 20 percent between the third quarter of 2015 and the second quarter of 2016. Over the same time period, the year-over-year growth rate for FHA purchase loans accelerated 25 percent. Atlanta is one of the country's fastest growing markets, where purchase demand is facilitated by the availability of credit made possible with FHA loans. As a result, our loan application defect and fraud risk index for Atlanta has shown significant improvement as well. In particular, loan application and defect risk in Atlanta is down over 12 percent in August compared to a year ago and is down an amazing 70 percent compared to the peak level of defect risk in November 2011.

Charlotte is another southern city experiencing a renaissance and purchase loan demand boom. The year-over-year growth rate for purchase loans in Charlotte accelerated 16 percent between the third quarter of 2015 and the second quarter of 2016, while the year-over-year growth rate for FHA purchase loans accelerated 25 percent between the same two periods. The loan application defect and fraud risk index is down over 15 percent in August compared to a year ago and is down 28.3 percent compared to the peak level of defect risk in September 2013.

"This month, rather than focus on markets with increased risk, we're highlighting markets that have improved — cool spots," said Fleming. "Atlanta and Charlotte, two southern cities experiencing large increases in demand for purchase mortgage loans, deserve the spotlight for the dramatic improvements in loan application defect and fraud risk they have both experienced in recent years. As purchase demand heats up, and FHA loan demand expands in Atlanta and Charlotte, loan application and defect risk has cooled — a sure benefit in an otherwise hot market."

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.