Market Dynamics Will Dictate Fraud Risk Outlook, According to First American’s Loan Application Defect Index

Stronger buyers’ market conditions and a rising share of refinance transactions – that’s what we need to maintain declining fraud risk momentum in 2019, says Chief Economist Mark Fleming


September 26, 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 August 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. 

August 2019 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications decreased by 3.9 percent compared with the previous month.

  • Compared to August 2018, the Defect Index decreased by 5.2 percent.

  • The Defect Index is down 28.3 percent from the high point of risk in October 2013.

  • The Defect Index for refinance transactions decreased by 4.3 percent compared with the previous month, and decreased by 4.3 percent compared with a year ago.

  • The Defect Index for purchase transactions decreased by 3.8 percent compared with the previous month, and is down 2.5 percent compared with a year ago.   

Chief Economist Analysis: Fraud Risk for Purchase Transactions Slides for Fifth Month

“Declining for the fifth consecutive month, the Loan Application Defect Index for purchase transactions continued its downward trend, falling 3.8 percent in August compared with July. The Defect Index for refinance transactions also fell, declining 4.3 percent compared with the previous month,” said Mark Fleming, chief economist at First American. “The overall Defect Index, which includes both purchase and refinance transactions, fell 3.9 percent compared with last month, and is 5.2 percent lower than one year ago.

“The overall Defect Index has not been this low since January 2017. However, falling defect risk is a recent phenomenon,” said Fleming. “In late 2018 and early 2019, overall defect risk rose at a fast pace and continued to do so until reaching a peak in February 2019. So, what sparked the slide in fraud risk in 2019?” 

Why is 2019 Different?

“Between July 2018 and February 2019, the overall Defect Index increased 25 percent. And then, it stopped. In the second half of 2018, rising mortgage rates reduced the share of refinance transactions, leading to a greater share of higher-risk purchase transactions. Additionally, hurricanes and wildfires in the second half of 2018 contributed to climbing defect risk,” said Fleming. “Our research indicates natural disasters go hand-in-hand with rising loan application defect risk, as natural disasters create greater opportunity for misrepresentation of collateral condition. But, 2019 provided a fresh start. In addition to fewer natural disasters, there are two primary reasons why 2019 has been the year of declining fraud risk.” 

1. Market Dynamics Shift Toward Buyers

“Following the strong sellers’ market conditions throughout 2018, market dynamics shifted slightly toward buyers in 2019. Mortgage rates began to decline in January 2019 and are 0.8 percentage points lower in August than January,” said Fleming. “Meanwhile, household income, the other component of house-buying power, has continued to increase, rising 1.5 percent in August compared with January 2019. Falling mortgage rates and rising household income have boosted consumer house-buying power. On the supply side, while inventory remains tight, there has been some progress compared with 2018.

“House-buying power gains and improvements in inventory tilt the market toward the buyer. But, what is the connection to fraud risk? Potential home buyers feel less pressure to misrepresent information on a loan application when strong sellers’ market conditions wane, as the market is less competitive,” said Fleming.

2. Increase in the Share of Refinances

“For many homeowners, the most important consideration when deciding to refinance is whether the mortgage rate is sufficiently lower than their existing rate. The 30-year, fixed-rate mortgage in August averaged 3.6 percent, the lowest since October 2016,” said Fleming. “According to estimates, 11.6 million existing households would be refinancing candidates at a mortgage rate of 3.5 percent, compared with just 2.9 million households when the mortgage rate is 4.5 percent.

“As a result of lower rates, refinance applications are up 148 percent compared with one year ago, according to the latest MBA mortgage applications survey,” said Fleming. “Defect, fraud and misrepresentation risk is significantly lower on refinance transactions, so the reduced risk of fraud and misrepresentation in 2019, and August in particular, is largely due to the increasing share of lower risk refinance transactions within the mortgage market.” 

Will Buyers’ or Sellers’ Market Conditions Change Fraud Risk Outlook?

“Housing market conditions and fewer natural disasters have created a declining fraud risk environment in 2019, so far. However, lower mortgage rates and higher incomes typically result in more demand for homes,” said Fleming. “While inventory has made some gains, it has mostly been for higher priced homes. The supply for lower- and middle-priced homes remains tight.

“Increasing demand against limited supply means that the housing market could be poised for another strong sellers’ market, which could create a spike in fraud risk. The good news is that mortgage rates fell further in September, indicating even more refinances may be on the way,” said Fleming. “Stronger buyers’ market conditions and a rising share of refinance transactions – that’s what we need to maintain declining fraud risk momentum in 2019.” 

August 2019 State Highlights

  • The five states with a year-over-year increase in defect frequency are: Nebraska (+23.2 percent), Iowa (+17.6 percent), South Dakota (+13.9 percent), New York (+12.8 percent), and North Dakota (+8.4 percent).

  • The five states with a year-over-year decrease in defect frequency are: Florida (-16.7 percent), Delaware (-13.8 percent), Texas (-13.8 percent), Vermont (-12.5 percent), and Maryland (-11.7 percent). 

August 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. (+8.6 percent), Kansas City, Mo. (+6.8 percent), New York (+5.2 percent), Hartford, Conn. (+3.1 percent), and San Jose, Calif. (+2.9 percent).

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the greatest year-over-year decrease in defect frequency are: Houston (-22.7 percent), San Diego (-21.2 percent), Orlando, Fla. (-20.9 percent), Jacksonville, Fla. (-20.2 percent), and Tampa, Fla. (-18.4 percent). 

    Next Release

    The next release of the First American Loan Application Defect Index will take place the week of October 28, 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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