The overall risk of defects in mortgage applications decreased 1.2% in March compared with February but was up 3.8% compared with March 2017, according to First American’s Loan Application Defect Index.
Driving the year-over-year increase was the fact that the mortgage market is shifting to a purchase market. Purchase loans generally carry higher risk than refinances because borrower information is being collected for the first time.
Transactions involving second homes or investment properties also tend to carry elevated levels of defect risk.
As Mark Fleming, chief economist for First American, explains, the degree of risk can vary greatly from market to market.
“Interestingly, there appears to be a high concentration of markets with elevated defect risk in the Sun Belt states and a high concentration of markets with lower defect risk in the Rust Belt states,” Fleming says in a statement. “For example, Little Rock, Ark.; Miami; and Knoxville, Tenn. are currently the three riskiest markets in the country, while Rochester, N.Y.; Scranton, Pa.; and Toledo, Ohio are the least risky.”
So what conditions result in higher risk in certain markets?
“The characteristics of the properties and loans involved in the real estate transactions in a given time period play an important role,” Fleming explains. “Transactions involving condominiums tend to carry higher defect risk than transactions involving single-family homes.”
The overall rate of risk decreased 19.6% from the high point of risk in October 2013, when mortgage underwriting standards were much looser.
In March, the risk of defects in applications for refinances increased 1.4% compared with February and was 11.1% higher compared with March 2017.
The risk of defects in applications for purchases decreased 2.2% compared with the previous month but was up 2.3% compared with a year earlier.
“A common adage about real estate is that it’s local,” Fleming says. “The dynamics of one housing market can be very different from another depending on the local economy and access to natural amenities, like mountains or water.
“The levels of loan application defect, fraud and misrepresentation risk vary greatly based on local conditions as well,” he adds. “In fact, substantial differences exist among the 100 markets that we track. For example, the riskiest market [in March], Little Rock, Ark., is almost twice as risky as the safest market, Rochester, N.Y.”
As Fleming explains, defect risk levels can also change dramatically over time in any given market.
“In the last three months, six markets experienced an increase in defect, fraud and misrepresentation risk of more than 10 percent, while three other markets experienced a decrease of more than 10 percent,” he says. “The point is, just as real estate is driven by local market conditions, so is defect risk.”
