June 2016 Loan Application Defect Index

Loan Application Defect and Fraud Risk Declines Due to Benefits of Low Mortgage Rates

"We expect this trend to continue into July, as the impacts of 'Brexit' and global uncertainty keep rates low, triggering an increase in the volume of lower risk refinance loan applications," 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, decreased 1.4 percent in June as compared with May and decreased by 12.2 percent as compared with June 2015. The Defect Index, which reflects estimated mortgage loan defect rates over time, by geography and by loan type, is down 29.4 percent from the high point of risk in October 2013.

The Defect Index has fallen 5.3 percent over the last three months, and this trend shows no sign of abating. The index has been reaching new lows this year, continuing its long-term trend. Since its inception, the Defect Index has been consistently trending lower, apart from the increases in risk in 2013 and early 2015. There are two factors driving the long-term decline in the Defect Index, the impact of improvements to the systems and production standards mitigating risk throughout the lending industry, and the continued strength of refinance application activity due to low mortgage rates. According to the MBA, refinance activity is up slightly on a year-over-year basis.

The average rate for a 30-year, fixed rate mortgage was 3.57 percent, compared to 3.6 percent in May. Our research finds that refinance applications are inherently less risky than purchase applications, so defect and fraud risk declines as refinance applications become a larger share of the overall mix of loan applications.

The Defect Index for refinance transactions declined 3.2 percent month-over-month, and is 15.5 percent lower than a year ago. The Defect Index for purchase transactions declined 1.2 percent month-over-month, and is down 11.1 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 40.0 percent as compared to 23.7 percent for purchase transactions.

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

  1. Maine (+14.0%)
  2. North Dakota (+13.6%)
  3. Missouri (+10.0%)
  4. Montana (+5.3%)
  5. Alaska (+2.8%)

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

  1. Michigan (-31.4%)
  2. Florida (-21.8%)
  3. Delaware (-19.5%)
  4. Connecticut (-17.8%)
  5. New York (-17.6%)

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

  1. St. Louis (+9.9%)

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

  1. Detroit (-35.9%)
  2. Jacksonville, FL (-23.5%)
  3. Miami (-22.7%)
  4. Louisville/Jefferson, KY (-20.3%)
  5. Orlando, FL (-20.2%)

"We expect the declining loan application defect risk trend to continue into July, as the impacts of 'Brexit' and global uncertainty keep rates low, triggering an increase in the volume of lower risk refinance loan applications," said Mark Fleming, chief economist at First American.

Where in the Application is the Defect Risk?

In the post-crisis housing finance landscape, the attention paid to the borrower's ability-to-pay and emphasis on issuing loans that have a reasonable and sustainable mortgage payment has increased. In other words — income matters. Within the Loan Application Defect Risk Index, we also measure specific risk categories, including defect, misrepresentation and fraud risk associated with the reporting and documentation of income in a mortgage loan application (see the figure below).

If the income is being inaccurately measured or misrepresented intentionally in the loan application, the borrower's true ability-to-pay and the sustainability of the mortgage are incorrectly measured. Interestingly, the trend in income-related defect risk offers some good news. The risk related to income is down 3 percent over the last three months and more than 10 percent in the last year. This beneficial decline in income-related defect and misrepresentation risk is a benefit of the technological and process investments made by the lending industry to meet compliance and regulatory requirements. The result is better measurement at the loan application level of the borrower's ability-to-pay and more accurate identification of sustainable mortgages.

National Defect Index by Risk Category

"Income-related misrepresentation and fraud risk is declining, as loan underwriting standards have become more disciplined and as the lending industry have made compliance and regulatory driven investments," said Fleming. "We continue to improve our ability to accurately project a borrower's ability-to-pay and the sustainability of a mortgage — a benefit to consumers and lenders alike."

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.