First American: Defects Surge as Mortgage Rates Rise

First American Financial Corp., Santa Ana, Calif., said increased shares of higher-risk purchase transactions and the potential for more adjustable-rate mortgages amid the expected strong spring market means mortgage lenders should remain watchful for defect and fraud risk.

The company’s monthly Loan Application Defect Index showed the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased by 4.1 percent in February from January. From a year ago, the Defect Index increased by 1.3 percent. However, the Index is down by 25.5 percent from its high point in October 2013.

The Defect Index for refinance transactions increased by 3.4 percent month-over-month, but was 6.2 percent lower than a year ago. The Defect Index for purchase transactions increased by 2.4 percent from January and rose by 2.4 percent from a year ago.

“Defect, fraud and misrepresentation risk continues to respond to the shift in market composition,” said First American Chief Economist Mark Fleming. “Rising mortgage rates continue to increase the share of higher-risk purchase loan applications, but they are also incenting more borrowers to apply for ARMs. The savings for the consumer can be significant, but ARM loan applications have historically had higher defect, misrepresentation and fraud risk. The increasing popularity of adjustable rate mortgages is something to keep an eye on as the spring home buying season warms up.”

Other report highlights:

–States with the greatest year-over-year increase in defect frequency: Wyoming (+43.1 percent), North Dakota (+38.2 percent), Mississippi (+31.8 percent), South Dakota (+31.5 percent) and Montana (+26.5 percent).
–States with the greatest year-over-year decrease in defect frequency: Michigan (-9.6 percent), Connecticut (-9.0 percent), New York (-7.4 percent), Maryland (-5.4 percent) and California (-5.4 percent).
–Among the largest 50 metro areas, markets with the greatest year-over-year increase in defect frequency: Raleigh, N.C. (+27.7 percent); Birmingham, Ala. (+11.4 percent); St. Louis (+11.3 percent); Minneapolis (+11.1 percent); and Jacksonville, Fla. (+9.6 percent).
–Markets with the greatest year-over-year decrease in defect frequency: Detroit (-16.9 percent); Louisville/Jefferson, Ky. (-14.8 percent); Milwaukee (-14.1 percent); Austin, Texas (-12.0 percent); and Oklahoma City (-11.8 percent).