April 2018 Loan Application Defect Index

Why the Ability-to-Repay Rules are like a Steering Wheel Lock

"The ancillary benefit (of the ability-to-repay standards) has been fewer loan application defects and a 'steering wheel lock' on mortgage fraud risk," says Chief Economist Mark Fleming.

The First American Loan Application Defect Index showed that in April 2018:

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained the same compared with the previous month.
  • Compared with April 2017, the Defect Index increased by 1.2 percent.
  • The Defect Index is down 19.6 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions increased by 1.4 percent compared with the previous month, and is 7.6 percent higher than a year ago.
  • The Defect Index for purchase transactions decreased by 2.2 percent compared with the previous month, and is up 2.2 percent compared with 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. Arkansas (+16.7%)
  2. Wyoming (+13.5%)
  3. New Mexico (+13.0%)
  4. Virginia (+12.2%)
  5. Maryland (+10.8%)

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

  1. South Carolina (-13.3%)
  2. Louisiana (-12.9%)
  3. Minnesota (-10.6%)
  4. Alabama (-10.0%)
  5. Vermont (-9.6%)

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

  1. Virginia Beach, VA (+24.7%)
  2. Los Angeles (+18.5%)
  3. San Diego (+17.9%)
  4. Orlando, FL (+14.6%)
  5. Oklahoma City (+11.3%)

Among the largest 50 Core Based Statistical Areas (CBSAs), there are three markets with the highest year-over-year decrease in defect frequency.

  1. Austin, TX (-14.0%)
  2. Birmingham, AL (-13.8%)
  3. Raleigh, NC (-12.4%)
  4. Minneapolis (-11.9%)
  5. New Orleans (-11.0%)

"The ancillary benefit (of the ability-to-repay standards) has been fewer loan application defects and a 'steering wheel lock' on mortgage fraud risk," said Mark Fleming, chief economist at First American.

Why the Ability-to-Repay Rules are like a Steering Wheel Lock

In January of 2013, the mortgage industry witnessed the birth of a new income-underwriting era. The Consumer Finance Protection Bureau (CFPB) published new requirements for mortgage lenders to carefully assess a consumer's ability to repay their mortgage loan. The new standards were dubbed the "ability-to-repay" rules and were set to take effect one year later in January 2014.

The "ability-to-repay" rules were intended to discourage the use of high-risk stated income loans that were common during the housing boom. The new rules also required lenders to strengthen the mortgage loan manufacturing and underwriting practices associated with the determination of a consumer's ability to repay. But, what impact did the ability-to-repay rules have on loan application misrepresentation, defect and fraud risk?

Income-Specific Loan App Defect Risk Crashes Since December 2012

Since the ability-to-repay rules were issued, there has been a precipitous and significant decline in income-specific mortgage loan application misrepresentation, defect and fraud risk. In fact, our income-specific metric within the Loan Application Defect Index (LADI) reached its peak in December 2012, one month before the rules were issued. By September 2013, nine months later, the income-specific defect risk metric declined 33 percent, as lenders implemented new loan manufacturing and underwriting practices in preparation for the effective start of rule in January 2014. Since then, income-specific defect and fraud risk has continued to decline and is currently 70 percent below its peak prior to publication of the ability-to-repay rules.

The ability-to-repay standards require mortgage lenders to make a reasonable and good faith determination of the consumer's ability to repay their mortgage. The rules have reduced the incentive to fraudulently misrepresent one's income, a benefit to lenders. The ability-to-repay standards are essentially the mortgage fraud risk prevention equivalent of using a steering wheel lock to dissuade potential car thieves.

Additionally, in order to make the good faith determination, the mortgage industry enhanced the manufacturing and underwriting practices specific to the assessment of a consumer's income and ability to repay their mortgage. This has helped to reduce income-related loan application defects.

The intent of the ability-to-repay standards was to help consumers secure mortgages that they can reasonably expect to repay. The ancillary benefit has been fewer loan application defects, and a steering wheel lock on mortgage fraud risk.

Chart: Defect Risk in the Ability to Repay Era

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 wealth management services. With total revenue of $5.8 billion in 2017, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2018, First American was named to the Fortune 100 Best Companies to Work For® list for the third consecutive year. 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. © 2018 by First American. Information from this page may be used with proper attribution.