December 2017 Loan Application Defect Index

Do Rising Rates Mean Rising Defect Risk?

"We have seen this before, in 2013, as mortgage rates rise, so does overall defect, fraud, and misrepresentation risk," says Chief Economist Mark Fleming.

The First American Loan Application Defect Index showed that in December 2017:

  • The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications remained the same compared with the previous month.
  • Compared to December 2016, the Defect Index increased by 20.3 percent.
  • The Defect Index is down 18.6 percent from the high point of risk in October 2013.
  • The Defect Index for refinance transactions remained unchanged compared to the previous month, and is 21.1 percent higher than a year ago.
  • The Defect Index for purchase transactions remained unchanged compared to the previous month, and is up 12.3 percent compared with a year ago.

Mark Explains the Loan Application Defect Index

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States with the highest year-over-year increase in defect frequency:

  1. South Dakota (+46.7%)
  2. New Mexico (+38.1%)
  3. Idaho (+31.6%)
  4. North Dakota (+31.1%)
  5. Nebraska (+29.3%)

There is one state with a year-over-year decrease in defect frequency:

  1. Connecticut (-1.5%)

Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with a year-over-year increase in defect frequency:

  1. Virginia Beach, VA (+39.7%)
  2. Orlando, FL (+32.9%)
  3. Oklahoma City (+31.9%)
  4. Miami (+31.3%)
  5. Las Vegas (+30.2%)

Among the largest 50 Core Based Statistical Areas (CBSAs), there is one market with a year-over-year decrease in defect frequency.

  1. Hartford, CT (-1.6%)

"Last month, I noted that defect, fraud and misrepresentation risk had finally stabilized after a significant, seven-month-long rise," said Mark Fleming, chief economist at First American. "Much of the elevated risk can be attributed to an increase in the share of purchase mortgage transactions, which tend to carry more risk. It's possible that all economists agree, a rarity, that mortgage rates will increase in 2018, which should increase the market share of purchase mortgage transactions, putting upward pressure on the overall risk of defect, fraud and misrepresentation."

How Do Rising Mortgage Rates Influence Defect, Fraud and Misrepresentation Risk?

  • The Defect Index illustrates the distinct difference in risk between refinance and purchase loan transactions, a distinction that has been consistent over time. Refinance loan transactions have always been less risky than purchase transactions, and this difference is more pronounced today than six years ago.
  • Currently, refinance loan transactions are 24 percent less risky than purchase transactions.
  • The Mortgage Bankers Association forecasts that the 30-year, fixed-rate mortgage rate will rise to 4.8 percent by the end of 2018.
  • Rising mortgage rates will reduce the consumer benefit of refinancing their existing loans, so the share of all mortgage transactions that are refinance transactions is expected to decline to 27 percent in 2018.
  • We can look to the recent past for a glimpse at how defect risk will change as mortgage rates increase. Between January and September 2013 mortgage rates increased by 1.1 percent. Over that same time period, the overall level of risk in the Defect Index increased by 7.5 percent.

'As the benefit of refinancing a mortgage declines for many consumers, the share of refinance loan transactions will likely decrease and the share of purchase transactions will increase. We have seen this before, in 2013, as mortgage rates rise, so does overall defect, fraud, and misrepresentation risk.'

Current Index Values

Methodology

The First American Loan Application Defect Index estimates the level of defects detected in the information submitted in mortgage loan applications processed by the First American FraudGuard® system. The index is based on the frequency with which defect indicators are identified. The Defect Index moves higher as greater numbers of defect indicators are identified. An increase in the index indicates a rising level of loan application defects. The index, nationally and in all markets, is benchmarked to a value of 100 in January 2011. Therefore, all index values can be interpreted as the percentage change in defect frequency relative to the defect frequency identified nationally in January 2011.

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; and banking, trust and investment advisory services. With revenues of $5.6 billion in 2016, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2016, First American was recognized by Fortune® magazine as one of the 100 best companies to work for in America. More information about the company can be found at www.firstam.com.

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. © 2018 by First American. Information from this page may be used with proper attribution.