First American: Loan App Defect/Fraud Risk at Historic Low Point

First American Financial Corp., Santa Ana, Calif., said its Loan Application Defect Index fell in May to its lowest point to date and improved to nearly 30 percent above its highest point nearly three years ago.

The Defect Index decreased by 2.7 percent in May from April and decreased by 9.9 percent from a year ago. The Defect Index fell by 28.4 percent from the high point of risk in October 2013. The index estimates frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications.

“Loan production expenses have been increasing, which reflects the industry’s investment in technology and improved standards, as well as greater demand for compliant loan production processes,” said First American Chief Economist Mark Fleming. “Now, additional data from the Mortgage Bankers Association shows that underwriters are taking more time to close each loan transaction. Productivity, which measures the number of loan applications processed per month by an underwriter, is down significantly from the rate of underwriting present at the height of the housing boom.”

The Defect Index for refinance transactions declined by 3.1 percent month-over-month and was 10 percent lower than a year ago. The Defect Index for purchase transactions declined by 2.4 percent month-over-month and by 11.4 percent from a year ago. Since defect risk for both purchase and refinance transactions peaked in late 2013, defect risk on refinance transactions continues to decline much more than defect risk for purchase transactions, declining 38.0 percent as compared to 22.1 percent for purchase transactions.

“Better technology and standards in the loan application process combined with more time spent underwriting each loan application may be increasing the cost of loan production, but we continue to see clear benefits too,” Fleming said. “While the costs of compliance are higher and reducing the profitability of mortgage lending, there is long-term financial benefit to increased loan quality. Fewer defects and less misrepresentation will reduce repurchase risk and expenses for underwriters in the future.”

Other report data:
–States with the highest year-over-year increase in defect frequency were North Dakota (19.3 percent), Maine (10.0 percent), Missouri (10.0 percent), Utah (5.2 percent) and Oklahoma (4.7 percent).
–States with the highest year-over-year decrease in defect frequency were Michigan (-27.5 percent), Florida (-20.0 percent), West Virginia (-16.9 percent), New Mexico (-16.5 percent) and Delaware (-16.0 percent).
–Among the largest 50 Core Based Statistical Areas, markets with the highest year-over-year increase in defect frequency were St. Louis (15.9 percent); Salt Lake City (4.0 percent); Oklahoma City (3.7 percent) and Houston (3.4 percent).
–Markets with the highest year-over-year decrease in defect frequency were Detroit (-33.0 percent); Jacksonville, Fla. (-21.4 percent); Miami (-20.2 percent); Hartford, Conn (-19.0 percent); and Buffalo, N.Y. (-17.6 percent).

Fleming said refinance loan transactions are 23.5 percent less risky than purchase loans; owner-occupied loans are 30.1 percent less risky than investor loans; single-family properties are 11 percent less risky than condos and FHA loans are 15 percent less risky than conventional loans.

“When rates begin to rise consistently higher, which is now less likely in 2016 given Britain’s decision to exit the European Union, there should be less refinance activity relative to purchase loan applications,” Fleming said. “We expect this relative shift away from lower risk refinancing to higher risk purchase loans will put upward pressure on the overall risk indices. More generally, because the indices don’t hold the ‘mix’ of refinance and purchase applications constant, the overall index measures the underlying risk trend, but also any change in the mix.”