Riskier Loans Not Leading to Higher Defect Levels

A transition away from lower-risk refinance transactions to a market dominated by riskier purchase loans has not translated to higher levels of fraud or defects among mortgage loans industry-wide, according to the First American Loan Application Defect Index for September 2016.

First American reported that the Defect Index, which measures frequency of defects, fraudulence, and misrepresentation in information submitted in mortgage loan applications, declined by nearly 15 percent over-the-year in September and is down by nearly one-third (32.3 percent) from its peak reached in October 2013.

For refinance transactions, the Defect Index was down by 17 percent in September, and for purchase transactions, the Defect Index was down by 8 percent from September 2015.

“More data-driven evidence is mounting that the millennial first-time homebuyer is playing an increasingly important role in the housing and mortgage finance markets,” said Mark Fleming, Chief Economist at First American. “The market is in transition toward a greater volume of riskier purchase loans, away from a market dominated by lower risk refinance loans. Yet, overall the defect index continues to decline, which is a testament to the effort the mortgage finance industry is making to improve the loan production process.”

Fraud, defect, and misrepresentation risk are declining and have reached very low levels in some markets, according to Fleming—and the main driver of the declines is increased use of technology.

“The widespread implementation of data- and technology-enabled loan manufacturing processes is benefiting consumers across the country,” Fleming said. “The mortgage finance industry continues to improve, producing loans with fewer defects and producing those loans right the first time.”

While some states reported over-the-year double-digit increases in defect frequency in September (Maine at 25.5 percent, North Dakota at 14.8 percent, South Dakota at 11.3 percent, and Vermont at 10.4 percent), First American reported that only one of the 50 largest core-based statistical areas (CBSAs) had a higher defect frequency in September (St. Louis, 1.4 percent higher) than in September a year ago. Additionally, the defect, fraud, and misrepresentation level in all 100 of the major metros tracked by First American has been below the benchmark national level (reached in January 2011) since February 2016.

“The defect risk levels across different markets are becoming more homogenous because the benefits of more robust and data-driven loan production processes apply equally from market to market,” Fleming said.