First American: Mortgage defect risk climbs 7.4% in December

Rising purchase applications and natural disasters contribute to rising defect risk

In December, defect risk continued to rise across the country, according to the latest First American Loan Application Defect Index.

According to the report, the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications climbed 7.4% from the previous month, increasing 4.8% from December 2017.

Nationally, the Defect Index for refinance transactions moved forward 8.2% from November and is up a whopping 14.5% from the same time a year ago. Notably, the Defect Index for purchase transactions rose 7.1% from November but remains 1.1% down from 2017.

“The fourth quarter of 2018 saw loan application defect risk rise significantly. Nationally, overall defect risk reached its highest point in more than four years,” First American Chief Economist Mark Fleming said. “In December, defect risk increased in every state compared with the previous month, and defect risk increased in 39 states year over year.”

According to Fleming, the trend can be attributed to two significant factors: the rising share of purchase transactions and natural disasters.

“In 2017, mortgage rates were consistently below 4%, but rates steadily increased throughout 2018, reaching a high of 4.8% in October 2018 before moderating slightly to 4.6% in December 2018,” Fleming said. “As mortgage rates rise, the incentive to refinance declines.”

“The share of refinance mortgage transactions dropped to 27% of the overall mortgage market in the fourth quarter of 2018, 10% lower than the previous year. While loan application defects can happen on either purchase or refinance transactions, there is a greater propensity for fraud and misrepresentation with purchase transactions,” Fleming continued. “We have seen this before, in 2013, as mortgage rates increased, so did overall defect, fraud and misrepresentation risk.”

Fleming said the company’s research also indicates that natural disasters go hand-in-hand with loan application defect risk, as natural disasters create the opportunity for misrepresentation of collateral condition.

“Unfortunately, this trend appears to be playing out in the aftermath of the tragic wildfires that struck California in late 2018,” Fleming said. “Before July, defect, fraud and misrepresentation risk was declining in California. Since July, California’s defect risk has steadily increased."

As of December, California fraud risk now sits 14.5% higher than one year ago, and 6% higher than November, according to Fleming. 

NOTE: First American’s Loan Application Defect Index measures the frequency of which defect indicators are identified. The index is benchmarked to a value of 100 in January 2011, meaning all index values are interpreted as the percentage change in defect frequency relative to that time, according to the company.

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