Loan Application Defect and Fraud Risk Declines Due to Benefits of Low Mortgage Rates, According to First American Loan Application Defect Index

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


July 29, 2016, Santa Ana, Calif.

First American Financial Corporation (NYSE: FAF), a leading global provider of title insurance, settlement services and risk solutions for real estate transactions, today released the First American Loan Application Defect Index for June  2016, which estimates the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications. The Defect Index reflects estimated mortgage loan defect rates over time, by geography and by loan type. It’s available as an interactive tool that can be tailored to showcase trends by category, including amortization type, lien position, loan purpose, property and transaction types, as well as state and market comparisons of mortgage loan defect levels.

June Loan Application Defect Index

The First American Loan Application Defect Index decreased 1.4 percent in June as compared with May and decreased by 12.2 percent as compared with June 2015.

“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,” said Mark Fleming, chief economist at First American.

“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,” said Fleming. “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.

“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 Fleming.

June 2016 State Highlights

  • The five states with the highest year-over-year increase in defect frequency are: Maine (+14.0 percent), North Dakota (+13.6 percent), Missouri (+10.0 percent), Montana (+5.3 percent), and Alaska (+2.8 percent).
  • The five states with the highest year-over-year decrease in defect frequency are: Michigan (-31.4 percent), Florida (-21.8 percent), Delaware (-19.5 percent), Connecticut (-17.8 percent), and New York (-17.6 percent).

June 2016 Local Market Highlights

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the only one market with year-over-year increase in defect frequency is: St. Louis (+9.9 percent).
  • Among the largest 50 CBSAs, the five markets with the highest year-over-year decrease in defect frequency are: Detroit (-35.9 percent); Jacksonville, Fla. (-23.5 percent); Miami (-22.7 percent); Louisville/Jefferson, Ky. (-20.3 percent); and Orlando, Fla. (-20.2 percent).

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,” said Fleming. “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.”

“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,” said Fleming. “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.

“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.”

Next Release

The next release of the First American Loan Application Defect Index will be posted the week of August 22, 2016.

Methodology

The methodology statement for the First American Loan Application Defect Index is available at http://www.firstam.com/economics/defect-index.

Disclaimer

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.

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. 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.

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