What is Leading the Downfall of Defect Risks?

The frequency of defects, fraud, and misrepresentation in the information submitted in mortgage applications fell 3.9% in August, and the Defect Index has decreased 5.2% year-over-year, according to First American Financial Corporation. 

Overall, First American reports that the Defect Index is down 28.3% from its high point in October 2013.

The Defect Index for refinances declined by 4.3% compared to July, and is 4.3% lower than it was last year. Purchase transactions saw their defect index decline 3.8% in August, and a 2.5% decline compared to last July. 

“The overall Defect Index has not been this low since January 2017. However, falling defect risk is a recent phenomenon,” said Mark Fleming, Chief Economist at First American. 

Fleming added that the Defect Index rose 25% between July 2018 and February 2019. However, the second half of 2018 saw rates reduce the share of refinance transactions, leading to more high-risk purchase transactions. Also, natural disasters contributed to the climbing defect risk. 

He added that 2019 “provided a fresh start,” with fewer natural disasters, and two primary reasons leading to declining fraud risk: The market shifting toward buyers and an increase in refinance transactions. 

Fleming said mortgage rates began to decline in January 2019 and are 0.8 percentage points lower in August than in January. 

“Meanwhile, household income, the other component of house-buying power, has continued to increase, rising 1.5% in August compared with January 2019. Falling mortgage rates and rising household income have boosted consumer house-buying power. On the supply side, while inventory remains tight, there has been some progress compared with 2018,” he said. 

With additional homebuying power and rising incomes, Fleming said applications feel less pressure to misrepresent information on loan applications, as the market is less competitive. 

The report states that an estimated 11.6 million households would be candidates for refinancing at a mortgage rate of 3.5%, compared to just 2.9 million homes if the mortgage rate was 4.5%. Fleming said recent information from the Mortgage Bankers Association reveals lower rates have caused refinance applications to rise 148% year-over-year. 

“Defect, fraud and misrepresentation risk is significantly lower on refinance transactions, so the reduced risk of fraud and misrepresentation in 2019, and August in particular, is largely due to the increasing share of lower risk refinance transactions within the mortgage market,” he said.