Loan Application Defect and Fraud Risk Declines Due to Increased Demand for FHA Purchase Loans, According to First American Loan Application Defect Index

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


September 30, 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 August 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.

August Loan Application Defect Index

The First American Loan Application Defect Index remained unchanged in August as compared with July and decreased by 14.6 percent as compared with August 2015. The Defect Index is down 31.4 percent from the high point of risk in October 2013.

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

“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,” said Fleming. “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.”

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.

“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 Fleming. “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.”

August 2016 State Highlights

  • The five states with the highest year-over-year increase in defect frequency are: Maine (+19.2 percent), North Dakota (+13.6 percent), Missouri (+8.7 percent), Montana (+5.3 percent) and Vermont (+5.1 percent).
  • The five states with the highest year-over-year decrease in defect frequency are: Michigan (-29.4 percent), Florida (-23.8 percent), Arizona (-19.3 percent), Oklahoma (-19.1 percent), and New Mexico (-19.0 percent).

August 2016 Local Market Highlights

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the only market with a year-over-year increase in defect frequency is: St. Louis (+2.7 percent).
  • Among the largest 50 CBSAs, the five markets with the highest year-over-year decrease in defect frequency are: Detroit (-33.9 percent); Oklahoma City (-27.8 percent); Louisville/Jefferson, Ky. (-27.1 percent); Orlando, Fla. (-25.8 percent); and Jacksonville, Fla. (-24.7 percent).

Rising Purchase Demand Helps Drive Declining Defect 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,” said Fleming.

“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,” said Fleming. “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,” said Fleming. “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.”

Next Release

The next release of the First American Loan Application Defect Index will be posted the week of October 24, 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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