Policy, Fintech Innovation to Help Protect Against Fraud Risk in Days Ahead, According to First American’s Loan Application Defect Index
Today’s housing market benefits from new technology and policy guardrails against fraud and defect risk, innovations that will serve the industry well in the uncertain days ahead, says Chief Economist Mark Fleming
March 30, 2020, 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 2020, 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 2020 Loan Application Defect Index
The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications decreased by 4.6 percent compared with the previous month.
Compared to February 2019, the Defect Index decreased by 34.7 percent.
The Defect Index is down 39.2 percent from the high point of risk in October 2013.
The Defect Index for refinance transactions decreased by 5.5 percent compared with previous month, and decreased by 39.5 percent compared with a year ago.
The Defect Index for purchase transactions decreased by 2.6 percent compared with the previous month, and is down 23.2 percent compared with a year ago.
Chief Economist Analysis: Defect Index Falls to Lowest Point Ahead of Coronavirus Outbreak
“A historical view of overall defect risk, as measured by our Loan Application Defect Index, shows a long-run downward trend since we began tracking defect risk in 2011, with a few exceptions. In February 2020, this long-run trend continued as overall defect risk reached its lowest level in index history,” said Mark Fleming, chief economist at First American. “The Defect Index for purchase transactions fell by 2.6 percent compared with the previous month, while the Defect Index for refinance transactions fell by 5.5 percent, pulling the overall defect risk level to this new low point. While various dynamics drive fraud risk in the short run, there are two forces that have consistently reduced fraud risk over approximately the last 10 years: policy and technology innovation.”
The Ability-to-Repay Saves the Day
“In January of 2013, the Consumer Finance Protection Bureau (CFPB) published new requirements for mortgage lenders to carefully assess a consumer’s ability to repay their mortgage loan. The new “ability-to-repay” rules were implemented one year later in January 2014,” said Fleming. “This marked the beginning of a new income-underwriting era. The ‘ability-to-repay’ rules discouraged the use of high-risk loan products that were common during the housing boom. Instead, mortgage lenders are required to make a reasonable and good faith determination of the consumer’s ability to repay.
“To meet the new “ability-to-repay” standard, mortgage lenders standardized the mortgage loan manufacturing and underwriting practices associated with the determination of a consumer’s ability to repay,” said Fleming. “But, what impact did the ability-to-repay rules have on loan application defect, fraud and misrepresentation risk?
“Our income-specific metric within the Defect Index reached its peak in December 2012, one month before the rules were issued. By December 2013, one year later, the income-specific defect risk metric had declined 33 percent, as lenders implemented new loan manufacturing and underwriting practices in preparation for the effective start of the rule in January 2014,” said Fleming. “Since then, income-specific defect and fraud risk has continued to decline and is currently 60 percent below its peak prior to publication of the ability-to-repay rules.”
Data-Driven Innovation, Automation
“The mortgage finance industry’s significant investment in financial technology is the other major driver of the long-run decline in fraud risk. For example, advancements in mortgage technology allow lenders to compare a borrower’s information against employment databases and other data sources, and algorithms can inspect whether recent bank account deposits are consistent with a borrower’s paystubs,” said Fleming. “Technology can also be used to flag missing or inconsistent data. These advancements, which help to deliver a convenient, digital, highly automated and all-around better home-buying experience, have also enhanced the mortgage manufacturing and underwriting process, producing declining levels of defect risk.
“There’s a lot of uncertainty in the economy and mortgage markets these days. While fraud risk will never be zero, it is certainly in a better place today than it was nearly a decade ago,” said Fleming. “Today’s housing market benefits from new technology and policy guardrails against fraud and defect risk, innovations that will serve the industry well in the uncertain days ahead.”
February 2020 State Highlights
There is no state with a year-over-year increase in defect frequency.
The five states with the greatest year-over-year decrease in defect frequency are: West Virginia (-51.0 percent), North Carolina (-42.9 percent), Indiana (-42.3 percent), Montana (-42.2 percent), and Virginia (-42.2 percent).
February 2020 Local Market Highlights
Among the largest 50 Core Based Statistical Areas (CBSAs), there is no market with a year-over-year increase in defect frequency.
Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the greatest year-over-year decrease in defect frequency are: Richmond, Va. (-44.3 percent), Detroit (-43.3 percent), Virginia Beach, Va. (-43.0 percent), San Diego (-41.2 percent), and Indianapolis (-41.1 percent).
The next release of the First American Loan Application Defect Index will take place the week of April 27, 2020.
The methodology statement for the First American Loan Application Defect Index is available at http://www.firstam.com/economics/defect-index.
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. © 2020 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 $6.2 billion in 2019, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2020, First American was named to the Fortune 100 Best Companies to Work For® list for the fifth consecutive year. More information about the company can be found at www.firstam.com.