Mortgage Application Defect Rate Fell Again But Trend Could Soon Reverse

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The frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage applications fell by 1.5% in December compared with November and was down 16% compared with a year ago, according to First American’s Loan Application Defect Index.

As of December, the index was down 34.3% from the high point of risk in October 2013.

The frequency of defects in applications for refinances decreased by 3.3% compared with November and was down 26.6% compared with December 2018.

The frequency of defects in applications for purchases increased by 1.3% compared with the previous month but was down 13.3% compared with a year earlier.

“Defect, fraud and misrepresentation risk is significantly lower on refinance transactions, so the rise and fall of the share of higher risk purchase activity can significantly impact the overall index,” explains Mark Fleming, chief economist for First American, in a statement. “The refinance share of the market was 30 percent in the first quarter of 2019 and is anticipated to have increased to 51 percent in the fourth quarter of 2019, as purchase transaction volume declines significantly during the holidays.

“Despite a slight increase in mortgage rates in December, applications to refinance a home increased 146 percent compared with the same month one year ago,” Fleming says. “The increase in the share of lower risk refinance transactions relative to purchase transactions contributed to the decline in overall fraud risk.

In general, applications for refinances have a lower defect risk than applications for purchases because borrower information has previously been collected and verified.

Fleming says a rise in share of purchase transactions and a strengthening sellers’ market may result in increased fraud risk.

“Overall fraud risk did not increase in a single state or metropolitan area relative to one year ago, but fraud risk did rise in several markets on a month-over-month basis,” he says. “While declining fraud risk is the new norm, should market composition shift back toward a greater share of higher-risk purchase transactions, or the sellers’ market strengthens even further, we can expect an even slower pace of decline, or even a return to rising fraud risk.”

First American’s report reflects estimated mortgage loan defect rates over time, by geography and by loan type.

“For the majority of 2019, overall fraud risk steadily declined, largely due to the rising volume of lower risk refinance transactions driven by low mortgage rates,” Fleming says. “After falling since March, overall defect risk stabilized in November, and then declined again in December. The overall Defect Index, which includes both purchase and refinance transactions, fell 1.5 percent compared with November, and is 23 percent lower than one year ago.

“While overall fraud risk declined in December, the pace of decline was slower than earlier in the year,” he adds. “The Defect Index for purchase transactions increased 1.3 percent compared with November, while the Defect Index for refinance transactions fell 3.3 percent, its ninth straight month of declining risk.”

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