After increasing for eight consecutive months, the frequency of defects in applications for mortgage loans decreased 4.2% in April compared with March, due mainly to falling interest rates leading to an increase in refinance share, according to First American Financial Corp.’s Loan Application Defect Index.
In general, purchase loans have a greater occurrence of fraud and misrepresentation, as borrowers are – more often than not – presenting personal data for the first time. When a borrower refinances, however, information has already been collected and verified, reducing the incidence of “defects” in the application.
As result, when the refinance share increases, the rate of defects in loan applications goes down. And when the purchase share increases (and the refinance share shrinks) the rate goes up.
In addition, the decrease in mortgage rates has resulted in a less competitive housing market, which means that fewer buyers feel pressured to misrepresent their income or other data in the application in order to buy a larger home.
As Mark Fleming, chief economist of First American explains, the decrease in mortgage rates helped “alleviate some of the supply constraints that made the housing market so competitive.”
“As we saw in last month’s report, in extremely competitive markets, there is more motivation to misrepresent information on a loan application to qualify for the bigger mortgage in order to win the bidding war,” Fleming says in the report.
“Most recently, real estate agents indicate that their buyers are encouraged by an unexpected surge of supply,” Fleming explains. “April did see an increase in total housing inventory, rising to 1.83 million from 1.67 million in March, which is a 1.7% increase year-over-year.
“Potential buyers feel less inclined to misrepresent information on a loan application when they don’t feel the pressure of a hot sellers’ market,” he adds. “Indeed, misrepresentation of income and employment both fell [in April], by 1.7 percent and 3.6 percent respectively.”
So if rates continue to fall, and competitive pressure continues to shrink, will it result in even lower levels of application defects in the months to come?
“It remains to be seen if mortgage rates, now flirting with four percent, will go any lower,“ Fleming says. “If so, we may anticipate the continued downward trend in defect risk and misrepresentation, with further increases in refinance transactions and inventory, resulting in less pressure on the market.”
Still, those eight straight months of increases in the index, resulting from the shift to a purchase market, have taken their toll: Compared to April 2018, the index has increased by 11.0%.
Still, the index is down 10.8% from the high point of risk in October 2013.
The rate of application defects for refinance transactions decreased by 3.5% in April compared with March, but was up 16.9% compared with April 2018.
The rate of defects in purchase transactions fell by 4.0% compared with the previous month but was up 10.3% compared with a year earlier.