The Loan Application Defect Index (LADI), courtesy of First American Mortgage Solutions, remained steady in February compared with the prior month but is now 3.2% higher than February 2019; the LADI for purchase loan transactions increased by 1.2% compared with the previous month and is now more than 13% higher than one year ago. Meanwhile, defect risk for refinance transactions remained the same relative to last month, but is about 4% higher than one year ago.
First American's LADI is updated monthly during the last week of the month.
The 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 data—which delves into whether the information on a loan is correct, misrepresented, or even potentially fraudulent— is useful when assessing the amount of risk on a loan, according to First American's economists.
First American's Deputy Chief Economist Odeta Kushi offers some insight into this month's report, including some thoughts on how the rise in mortgage rates will impact refinancing and, as a result, increase risks for lenders.
"The recent refinance boom appears to be over and that likely means defect risk is poised to rise in the months ahead. According to the latest Mortgage Bankers Association forecast, refinance transactions will make up 44% of total mortgages originated by the second quarter of 2021, compared with an estimated 69% in the first quarter of the year," Kushi said. "The average 30-year, fixed mortgage rate increased by 0.08 percentage points in February—the greatest monthly increase since October 2019. Since many homeowners have benefitted from the super low-rate environment, they have very little incentive to refinance now that rates are on the rise."
This ongoing shift matters to lenders, Kushi pointed out, because First American's defect index has historically illustrated that refinance loan transactions are less risky than purchase transactions.
Though rates are rising, they remain relatively low—that, combined with inventory shortages make for a highly competitive market.
"The shift to a purchase-dominated market, and a hot one at that, will likely put upward pressure on overall fraud risk in the months to come," Kushi concludes.