Loan Application Defect Risk in Adjustable-Rate Mortgages Slips Below Fixed-Rate Mortgages, According to First American’s Loan Application Defect Index

Today’s ARM is not like those of the past. It is essentially the same as the 30-year, fixed-rate mortgage with one difference – rates adjust after an initial fixed period of usually five or seven years, says Chief Economist Mark Fleming


March 29, 2018, 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 2018, 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 loan type. It is 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, and can provide state- and market-specific comparisons of mortgage loan defect levels.

February 2018 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained the same compared with the previous month.
  • Compared to February 2017, the Defect Index increased by 9.2 percent.
  • The Defect Index is down 18.6 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions remained unchanged compared to the previous month and is 13.1 percent higher than a year ago.
  • The Defect Index for purchase transactions decreased by 1.1 percent compared with the previous month and is up 7.1 percent compared with a year ago.

Chief Economist Analysis: Will the Return of ARMs Lead to Surging Loan App Defect Risk?

“It’s been a long time coming – a rising rate environment. The 30-year, fixed-rate mortgage has been below 4.5 percent since late 2013 and is now finally moving consistently higher. According to the consensus of economic forecasts, it is likely to approach 5 percent by the end of this year,” said Mark Fleming, chief economist at First American. “This matters for defect, fraud and misrepresentation risk as rising mortgage rates reduce the benefit of refinancing and increase the share of purchase loan transactions in the market. As we have noted before, purchase loan transactions are riskier than refinance transactions.

“But, there is another reason why a rising rate environment matters for defect, fraud and misrepresentation risk. The allure of the adjustable-rate mortgage (ARM) increases,” said Fleming. “The current rate on a 30-year, fixed-rate mortgage is approximately 4.5 percent. Yet, there is another mortgage option – the ARM, which typically has a lower rate than the traditional 30-year, fixed-rate mortgage. Currently, ARMs are available at about 4 percent. As rates increase and borrowers seek to keep their monthly payment low, more borrowers are likely to choose the adjustable-rate option.”

“ARMs historically have had more defect, fraud and misrepresentation risk than the traditional 30-year, fixed rate mortgage,” said Fleming. “Interestingly, that has changed recently. ARMs, based on our defect, fraud and misrepresentation index, are modestly less risky.

“At the height of the housing boom, ARMs were all the rage, and many included additional elements that added risk, such as negative amortization, payment-option and interest-only options, and teaser rate ARMs. Today’s ARM is not like those of the past,” said Fleming. “It is essentially the same as the 30-year, fixed-rate mortgage with one difference – rates adjust after an initial fixed period of usually five or seven years. Saving half a percent on the mortgage rate may be worthwhile for many consumers, especially if their expected tenure length in the house is not 30 years.

“As mortgage rates continue to rise, the share of ARMs is also likely to increase and, if current defect risk patterns hold, will offset some of the increased risk the market will bear as it shifts to purchase transactions.”

February 2018 State Highlights

  • The five states with the greatest year-over-year increase in defect frequency are: South Dakota (+28.2 percent), Wyoming (+20.5 percent), New Mexico (+19.4 percent), Oregon (+18.6 percent) and Delaware (+18.5 percent).
  • There are three states with a year-over-year decrease in defect frequency: Louisiana (-9.8 percent), Connecticut (-5.6 percent) and Minnesota (-5.0 percent).

    February 2018 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 are: Virginia Beach, Va. (+24.3 percent), Oklahoma City (+22.7 percent), Portland, Ore. (+21.2 percent), Los Angeles (+20.0 percent), and Cleveland (+18.8 percent).
  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the largest year-over-year decrease in defect frequency are: Minneapolis (-7.5 percent), Austin, Texas (-4.9 percent), Raleigh, N.C. (-4.8 percent), Hartford, Conn. (-1.5 percent), and Pittsburgh (-1.5 percent).

    Next Release

    The next release of the First American Loan Application Defect Index will take place the week of April 23, 2018.

    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. © 2018 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 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.

###

myFirstAm®

Access the powerful online services available only at First American.

Sign In
Forgot Username or Password?

Sign Up

Sign up for a myFirstAm® account.

Other Platforms

  • FASTWeb

    Title ordering, routing and tracking.

  • AgentNet®

    eJackets, closing protection letters, back title, bulletins and more.

  • DataTree.com

    Access the nation's largest land record database.

  • Home Warranty

    Coverage for a home's major systems and appliances.