Defect, Fraud and Misrepresentation Risk Surges Higher As Mortgage Rates Rise, According to First American Loan Application Defect Index

Increased share of higher risk purchase transactions and the potential for more adjustable rate mortgages amid the expected strong spring market means mortgage lenders should remain watchful for defect and fraud risk, says Chief Economist Mark Fleming


March 24, 2017, 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 February 2017, 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.

February 2017 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased 4.1 percent in February 2017 as compared with the previous month.
  • Compared to February 2016, the Defect Index increased by 1.3 percent.
  • The Defect Index is down 25.5 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions increased 3.4 percent month-over-month, and is 6.2 percent lower than a year ago.
  • The Defect Index for purchase transactions increased 2.4 percent compared to last month, and is up 2.4 percent compared to a year ago.

Chief Economist Analysis: Rising Rates Spurs Demand for Historically Riskier Loan Products

“This month, the Loan Application Defect Index surged higher as rising mortgage rates continue to put downward pressure on lower risk mortgage refinance activity. The March rate increase by the Federal Open Market Committee and strong economic performance will continue to pressure rates upward,” said Mark Fleming, chief economist at First American.

“Defect, fraud and misrepresentation risk continues to respond to the shift in market composition. Rising mortgage rates continue to increase the share of higher risk purchase loan applications, but they are also incenting more borrowers to apply for ARMs. The savings for the consumer can be significant, but ARM loan applications have historically had higher defect, misrepresentation and fraud risk,” said Fleming. “The increasing popularity of adjustable rate mortgages is something to keep an eye on as the spring home buying season warms up.

“As the spring home buying season gets underway in earnest, the volume of higher risk purchase applications will grow and further increase loan application defect and fraud risk. The increased share of higher risk purchase transactions and the potential for more adjustable rate mortgages amid the expected strong spring market means mortgage lenders should remain watchful for defect and fraud risk,” said Fleming.     

Additional Quotes from Chief Economist Mark Fleming

  • “The average rate for a 30-year, fixed-rate mortgage was 4.15 percent in February, which continued to put downward pressure on the volume of lower risk mortgage refinances.”
  • “As mortgage rates increase, some borrowers will seek affordability by switching from 30-year, fixed-rate mortgages to less expensive adjustable rate mortgages (ARMs).” 
  • “The 5/1 ARM averaged 3.2 percent in February, almost a full percentage point less than the traditional fixed-rate mortgage.”
  • “According to the Mortgage Bankers Association Application survey, the share of ARM applications reached its highest level in over a year at 7.5 percent of total applications.”
  • “Over the last three months, loan application, defect and fraud risk has increased by 5.6 percent on ARM loan applications.”
  • “While there is no significant difference in risk between ARMs and fixed-rate mortgages today, historically ARM loan applications have been the riskier loan product type.”

February 2017 State Highlights

  • The five states with the greatest year-over-year increase in defect frequency are: Wyoming (+43.1 percent), North Dakota (+38.2 percent), Mississippi (+31.8 percent), South Dakota (+31.5 percent), and Montana (+26.5 percent).
  • The five states with the greatest year-over-year decrease in defect frequency are: Michigan (-9.6 percent), Connecticut (-9.0 percent), New York (-7.4 percent), Maryland (-5.4 percent), and California (-5.4 percent).

    February 2017 Local Market Highlights

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the greatest year-over-year increase in defect frequency is: Raleigh, N.C. (+27.7 percent); Birmingham, Ala. (+11.4 percent); St. Louis (+11.3 percent); Minneapolis (+11.1 percent); and Jacksonville, Fla. (+9.6 percent).
  • Among the largest 50 CBSAs, the five markets with the greatest year-over-year decrease in defect frequency are: Detroit (-16.9 percent); Louisville/Jefferson, Ky. (-14.8 percent); Milwaukee (-14.1 percent); Austin, Texas (-12.0 percent); and Oklahoma City (-11.8 percent).

    Next Release

    The next release of the First American Loan Application Defect Index will be posted the week of April 24, 2017.

    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. © 2017 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 $5.6 billion in 2016, the company offers its products and services directly and through its agents throughout the United States and abroad. In both 2016 and 2017, 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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