Falling Rates Drive Acceleration in Defect Risk, According to First American’s Loan Application Defect Index

The overall rise in purchase and refinance applications, coupled with strong first-time home buyer demand and tight inventory, bodes well for an early spring home-buying season, but may contribute to further increases in defect risk, says Chief Economist Mark Fleming


February 28, 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 January 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. 

January 2019 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased by 4.6 percent compared with the previous month.

  • Compared to January 2018, the Defect Index increased by 9.6 percent.

  • The Defect Index is down 10.8 percent from the high point of risk in October 2013.

  • The Defect Index for refinance transactions increased by 5.1 percent compared with the previous month, and is up 20.3 percent compared with a year ago.

  • The Defect Index for purchase transactions increased by 5.6 percent compared with the previous month, and is up 3.3 percent compared with a year ago.   

Chief Economist Analysis: Why is Defect Risk Accelerating?

“The Loan Application Defect Index for purchase transactions continued its upward trend, increasing 5.6 percent in January compared with the month before, the fifth consecutive month defect risk in purchase transactions has risen,” said Mark Fleming, chief economist at First American. “Overall, the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased by 4.6 percent compared with the previous month. While overall fraud risk has been on the rise since July 2018 due partially to the impact of natural disasters, the last two months have experienced an acceleration in fraud risk – what could be driving this change?” 

Plunge in Rates, Spike in Mortgage Applications

“Surprisingly, mortgage rates declined in December and continued falling into January, reaching their lowest levels since April 2018. Prospective home buyers and existing homeowners reacted to the lower rates, resulting in a mini-boom in mortgage applications, both purchase and refinance,” said Fleming. “In fact, according to the Mortgage Bankers Association, overall mortgage application volume increased 23.5 percent for the week ending on January 4, 2019. The decline in mortgage rates spurred a flurry of refinance activity, with refinance applications surging 35 percent week-to-week to their highest level since July 2018. Similarly, mortgage purchase applications jumped 17 percent.

“The Defect Index has historically illustrated a distinct difference in risk between refinance and purchase loan transactions – refinance loan transactions have always been less risky than purchase transactions. The relationship has often shown that as mortgage rates rise, so does overall defect, fraud and misrepresentation risk,” said Fleming. “As mortgage rates rise, fewer people refinance, so the share of less risky refinance loan transactions decreases and the share of more risky purchase transactions increases. This dynamic played out throughout most of 2018, as rates were rising. However, the forces driving the acceleration in fraud risk over the last two months are a little less clear because the recent decline in mortgage rates prompted a surge in both purchase and refinance mortgage applications.” 

Rising Demand, Competitive Market May Contribute to Increasing Fraud Risk

“The overall rise in purchase and refinance applications, coupled with strong first-time home buyer demand and tight inventory, bodes well for an early spring home-buying season, but may contribute to further increases in defect risk. Historically, purchase transactions tend to be more at risk of defects, fraud and misrepresentation, and the pressures resulting from rising demand and a strong sellers’ market compounds that risk,” said Fleming. “When home values are rising and the housing market is competitive, more buyers want to enter in the market. As a result, misrepresentation and fraud are more likely on a loan application.

“Last week, mortgage rates fell even further to 4.35 percent, their lowest level since February 2018. As home buyers continue to take advantage of this lower rate environment amid a very competitive market, we can expect fraud risk will continue to trend higher.” 

January 2019 State Highlights

  • The five states with the greatest year-over-year increase in defect frequency are: West Virginia (+37.5 percent), Maine (+35.8 percent), New York (+35.5 percent), Nebraska (+33.3 percent), and Alaska (+30.7 percent).

  • The five states with the greatest year-over-year decrease in defect frequency are: Vermont (-12.8 percent), Florida (-5.1 percent), Arkansas (-3.7 percent), Arizona (-3.6 percent), and Ohio (-1.3 percent). 

    January 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: Richmond, Va. (+33.8 percent), Pittsburgh (+29.2 percent), Buffalo, N.Y. (+26.5 percent), San Jose, Calif. (+26.5 percent), and Hartford, Conn. (+25.4 percent).

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the largest year-over-year decrease in defect frequency are: Jacksonville, Fla. (-13.3 percent), Houston (-11.5 percent), Orlando, Fla. (-7.3 percent), Tampa, Fla. (-5.3 percent), and Miami (-4.8 percent). 

    Next Release

    The next release of the First American Loan Application Defect Index will take place the week of March 25, 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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