Two Competing Forces Stabilize Defect Risk, According to First American’s Loan Application Defect Index

Sellers’ market conditions increased fraud risk, but the rising share of lower-risk refinance transactions reduced fraud risk, says Chief Economist Mark Fleming


April 30, 2019, 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 March 2019, 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. 

March 2019 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained unchanged compared with the previous month.

  • Compared to March 2018, the Defect Index increased by 15.9 percent.

  • The Defect Index is down 6.8 percent from the high point of risk in October 2013.

  • The Defect Index for refinance transactions remained the same compared with previous month, and is up 22.9 percent compared with a year ago.

  • The Defect Index for purchase transactions increased by 1.0 percent compared with the previous month, and is up 12.4 percent compared with a year ago.   

Chief Economist Analysis: Colliding Trends Slow Defect Risk Growth

“Loan application defect risk for purchase transactions continued its upward trend in March, increasing 1.0 percent month-over-month, according to the Loan Application Defect Index. Defect risk for purchase transactions has risen for seven consecutive months, however, the pace of growth slowed to its lowest point over that time span,” said Mark Fleming, chief economist at First American. “Overall, the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained the same compared to the previous month, ending the trend of increasing risk that started in July 2018. But, what could be driving this change?

“Nationally, defect risk continued to surge in early 2019 and in February reached its highest point since 2013,” said Fleming. “Suddenly in March, the acceleration stopped. Two recent trends influenced defect risk in opposite directions and drove the moderation in defect risk.”


1. Rising Share of Refinance Transactions

“In 2018, mortgage rates steadily increased, reaching a high of 4.9 percent in November, before reversing course in December. Mortgage rates have been declining ever since, reaching 4.27 percent in March, 0.17 percentage points lower than one year ago,” said Fleming. “As mortgage rates fall, the incentive to refinance increases. In the first quarter of 2019, the share of refinance mortgage transactions increased to 32 percent of the overall mortgage market , a 5 percent increase over the prior quarter.”

“While loan application defects can happen on either purchase or refinance transactions, there is a lower propensity for fraud and misrepresentation with refinance transactions,” said Fleming. “So, as the share of lower-risk refinance transactions increases, overall fraud risk tends to decline.”   

2. Sellers’ Market Continues

“While declining mortgage rates spurred refinance activity, they’ve also encouraged potential home buyers to return to the market. In the first quarter of 2019, declining mortgage rates, ongoing household income growth and moderating unadjusted home prices boosted affordability,” said Fleming. “Yet, the increased demand for housing is occurring in a supply-constrained market, resulting in another sellers’ market this spring. In these competitive conditions, there is more motivation to misrepresent information on a loan application to qualify for the bigger mortgage necessary to win the bidding war for a home. In fact, employment misrepresentation increased 2.9 percent compared with the previous month.” 

End Result: Defect Risk Stabilizes

“The two competing trends stabilized the risk of defects, fraud and misrepresentation in March. Sellers’ market conditions increased fraud risk, but the rising share of lower-risk refinance transactions reduced fraud risk,” said Fleming. “The tug-of-war between the hot sellers’ market and the mix of refinance and purchase transactions will heavily influence the direction of fraud risk in the months ahead.” 

March 2019 State Highlights

  • The five states with a year-over-year increase in defect frequency are: Nebraska (+41.9 percent), New York (+41.3 percent), Iowa (+39.5 percent), West Virginia (+37.8 percent), and Maine (+36.2 percent).

  • There is one state with a year-over-year decrease in defect frequency: Arkansas (-0.9 percent). 

March 2019 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: Buffalo, N.Y. (+40.6 percent), Richmond, Va. (+40.3 percent), Pittsburgh (+33.8 percent), Raleigh, N.C. (+32.1 percent), and Cincinnati (+31.6 percent).

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the three markets with a year-over-year decrease in defect frequency are: Jacksonville, Fla. (-9.4 percent), Orlando, Fla. (-6.4 percent), and Houston (-5.3 percent). 

    Next Release

    The next release of the First American Loan Application Defect Index will take place the week of May 27, 2019. 

    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. © 2019 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; banking, trust and wealth management services; and other related products and services. With total revenue of $5.7 billion in 2018, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2019, First American was named to the Fortune 100 Best Companies to Work For® list for the fourth consecutive year. More information about the company can be found at www.firstam.com

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