According to the January 2017 Loan Application Defect Index compiled by the First American Financial Corporation, defect, fraud, and misrepresentation risk has increased as market composition shifts to riskier purchase transactions.
"While technology adoption has reduced risk for both purchase and refinance transactions, part of the overall decline in risk has been due to the recent dominance of refinance activity relative to purchase activity," said Mark Fleming, chief economist for First American. "As the mortgage market composition continues to shift toward purchase transactions in 2017, the risk of defect, fraud and misrepresentation will also increase.”
The First American Loan Application Defect Index estimates the level of defects detected in the information submitted in mortgage loan applications processed by the First American FraudGuard® system. An increase in the index indicates a rising level of loan application defects.
"In real estate, location matters. In defect, misrepresentation and fraud risk, loan purpose matters," Chief Economist Fleming said.
The First American Loan Application Defect Index showed that the frequency of defects, fraudulence, and misrepresentation in the information submitted in mortgage loan applications increased 5.8 percent in January 2017 as compared with the previous month. Compared to January 2016, the Defect Index decreased by 3.9 percent, and is down 28.4 percent from the high point of risk in October 2013.
As for refinance transactions, the Defect Index increased 3.5 percent month-over-month, and is 9.2 percent lower than a year ago. For purchase transactions, the Defect Index increased 2.5 percent compared to last month, and is down 1.2 percent compared to a year ago.
Fleming said that the market composition of purchase and refinance activity matters because analysis consistently finds refinance transactions to be less risky. Currently, refinance transactions have 30 percent less loan application defect, misrepresentation and fraud risk than purchase transactions. "Defect, misrepresentation and fraud risk is significantly lower on refinance transactions, so the increased risk of misrepresentation and fraud is due to the increasing share of higher risk purchase transactions within the mortgage market,” he added.
The last time the Loan Application Defect Index experienced a significant increase was also in mid-2015 in response to the decreasing share of refinance transactions in the market at the time.
The loan purpose risk gap, which measures the difference in risk between refinance and purchase loan transactions, has been increasing since October 2014 when the difference was only 4 percent.
States with the highest year-over-year increase in defect frequency are (1) Wyoming (+32.2 percent), (2) North Dakota (+29.0 percent), (3) Montana (+27.3 percent), (4) Mississippi (+25.4 percent); (5) Louisiana (+20.3 percent)
Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with a year-over-year increase in defect frequency are (1) Raleigh, North Carolina (+20.9 percent), (2) St. Louis (+14.5 percent), (3) Birmingham, Alabama (+7.4 percent), (4) Minneapolis (+5.5 percent), (5) Jacksonville, FL (+4.7 percent).
In the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the highest year-over-year decrease in defect frequency are (1) Louisville/Jefferson, Kentucky (-20.7 percent), (2) Detroit (-20.0 percent), (3) Oklahoma City (-17.4 percent), (4) Sacramento, CA (-15.8 percent), (5) Miami (-15.3 percent).