Rise in Refis Lowers Loan Defect Rate

First American Financial Corp., Santa Ana, Calif., said its Loan Application Defect Index held steady in March, driven in part by improving conditions for sellers and an uptick in mortgage refinancings.

The monthly index reported frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained unchanged in March compared to February. From a year ago, however, the Defect Index increased by nearly 16 percent, but fell by 6.8 percent from the high point of risk in October 2013.

The report said the Defect Index for refinance transactions remained the same in March compared to March, but rose by nearly 23 percent from a year ago. The Defect Index for purchase transactions increased by 1.0 percent in March and by 12.4 percent from a year ago.

First American Chief Economist Mark Fleming while defect risk for purchase transactions has risen for seven consecutive months, the pace of growth slowed to its lowest point over that time span. He said after a surge in defect risk in January and February, changing market conditions stopped the acceleration in March.

“In 2018, mortgage rates steadily increased, reaching a high of 4.9 percent in November, before reversing course in December,” Fleming said. “Mortgage rates have been declining ever since, reaching 4.27 percent in March, 0.17 percentage points lower than one year ago. As mortgage rates fall, the incentive to refinance increases…So, as the share of lower-risk refinance transactions increases, overall fraud risk tends to decline.”

Second, Fleming said, while declining mortgage rates spurred refinance activity, they’ve also encouraged potential home buyers to return to the market. “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,” he said. “Employment misrepresentation increased 2.9 percent compared with the previous month.”

Fleming added 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.

The report said states with a year-over-year increase in defect frequency in March were Nebraska (41.9 percent), New York (41.3 percent), Iowa (39.5 percent), West Virginia (37.8 percent) and Maine (36.2 percent). Arkansas (-0.9 percent) was the only state with a year-over-year decrease in defect frequency.

First American said among the largest 50 metros, markets with the greatest year-over-year increase in defect frequency were 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). Three markets saw a year-over-year decrease in defect frequency: Jacksonville, Fla. (-9.4 percent), Orlando, Fla. (-6.4 percent), and Houston (-5.3 percent).