Uptick in Fraud Risk Raises Eyebrows
First American Financial Corp., Santa Ana, Calif., said its monthly Loan Application Defect Index showed a jump in mortgage fraud risk for purchase transactions, the first such increase since last March.
The report said frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications in November remained the same as October. From a year ago, the Defect Index decreased by 16.0 percent and is down by 33.3 percent from the high point of risk in October 2013.
The report said the Defect Index for refinance transactions decreased by 1.6 percent from October and decreased by 17.8 percent from a year ago. The Defect Index for purchase transactions increased by 2.7 percent from October but fell by 8.3 percent from a year ago.
First American Chief Economist Mark Fleming said the direction of defect risk in 2020 is in large part dependent on mortgage rates and how many homeowners that are “in the money” choose to refinance.
“Overall defect risk has been declining since March of this year, and November marks a pause to this trend,” Fleming said. The reason for the change is two-fold. When house-buying power – i.e. how much home one can buy based on changes in household income and interest rates – falls in a supply-constrained market fraud risk may increase. Potential home buyers feel more confident and less inclined to commit fraud when they are in a better financial position to purchase a home. While house-buying power remains high, the pace of growth slowed beginning in October, when mortgage rates began to inch up.
Fleming noted in 2019, the average monthly growth rate of house-buying power through September was 1.6 percent. Over the two months of October and November combined, house-buying power declined by 0.6 percent. “The slowdown in house-buying power appreciation lessens the confidence of home buyers, so they may be more inclined to misrepresent information on a loan application, leading to an increase in the Defect Index for purchase transactions, he said.”
Secondly, Fleming noted a shift in market composition. “In November, the volume of mortgage applications dipped 2.2 percent relative to one year ago, mostly driven by the 8 percent decline in refinancing activity. Purchase activity, however, increased 7 percent relative to one year ago,” he said. “Defect, fraud and misrepresentation risk is significantly lower on refinance transactions, so the increased share of higher-risk purchase activity halted the decline in the overall defect index.”
Fleming said slightly higher mortgage rates through the end of the year could result in a small dip in house-buying power and a further pullback in refinance demand. “But, looking ahead to 2020, mortgage rates are expected to remain below 4 percent,” he said. “At that level, there are still 6.8 million borrowers today who could benefit financially by refinancing to a lower mortgage rate. As a result, the direction of defect risk in 2020 is in large part dependent on mortgage rates and how many homeowners that are ‘in the money’ choose to refinance.”
The report said no state showed a year-over-year increase in defect frequency. States with the greatest year-over-year decrease in defect frequency were Alaska (-34.8 percent), West Virginia (-31.8 percent), North Carolina (-27.0 percent), Virginia (-26.4 percent) Indiana (-24.1 percent). Among largest metros, no market showed a year-over-year increase in defect frequency. Markets with the greatest year-over-year decrease in defect frequency were Richmond, Va. (-30.9 percent), Virginia Beach, Va. (-30.2 percent), Oklahoma City (-27.2 percent), Raleigh, N.C. (-27.1 percent), and San Diego (-27.0 percent.)
