Why Is Loan Application Defect Risk Rising?

The frequency of defects, fraudulence, and misrepresentation in the information submitted in mortgage loan applications increased by 4.4 percent in February compared with the previous month, according to First American's latest Loan Application Defect Index. Year over year, the index rose 14.5 percent.

An increase in purchase loans as refis dried up and a competitive housing market with increasing home prices and low inventory for the most part of 2018 were responsible for this rise as buyers faced pressure to seek qualification for larger loan amounts, according to Mark Fleming, Chief Economist First American.

However, the index remained 6.8 percent lower than its October 2013 high. While the refinance index 24.6 percent in February compared with the same time last year, purchase defects rose 8.8 percent compared to February 2018, the report indicated.

A shift towards purchase loans was another factor that led to a rise in defects, according to Fleming.

"The shift in the mix of loan applications toward more purchase applications and pressure on borrowers likely fed the 2018 increase in income-specific defects," said Fleming. "Purchase loan applications typically are more likely to have fraud than refinance transactions. Furthermore, in the strong seller’s market we experienced in 2018, borrowers had more motivation to misrepresent income on a loan application in order to qualify for the bigger mortgage necessary to win the bidding war for a home.”

However, as mortgage rates began falling towards the end of 2018 and have remained in the low range since then, income-specific defects are also likely to plateau in 2019.

"Two thousand and eighteen ended the year with a decline in the 30-year, fixed-rate mortgage in December, a trend that has persisted through the first quarter of the year. Additionally, nominal house price appreciation in January sank to the slowest pace of growth since February 2015, according to the DataTree by First American House Price Index," Fleming said. "As affordability improves and demand increases going into the spring home-buying season, we expect the seller’s market conditions to return, potentially elevating income misrepresentation risk as well."