First American says nation’s low-interest rate environment has reduced mortgage defect risk

In July, America's mortgage defect index fell to a 3-year low

In July, America’s mortgage defect risk declined as falling  mortgage rates spurred an increase in refinance transactions, according to the latest First American Loan Application Defect Index.

According to First American, the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage applications decreased by 5% from the previous month.

However, when compared to the same time period in 2018, the nation’s defect risk remained relatively the same.  

“The overall Defect Index, which includes both purchase and refinance transactions, fell 5% compared with last month, and is at the same level as one year ago. Indeed, the only month the overall Defect Index has been lower was in October 2016,” First American Chief Economist Mark Fleming said. “Before we celebrate the decline in fraud risk, it’s important to understand the underlying shifts in the mortgage market that may be driving this decline.”

Fleming says July’s low defect risk can be attributed to low mortgage rates, which have eased market competition and led to an increase of lower-risk refinance transactions.

“This trend has surfaced in previous refinance booms. Fraud risk reached a low point in November 2016 amid the refinance boom between the fourth quarter of 2015 and third quarter of 2016, which pushed the share of refinance originations from 46% to 51%,” Fleming said. “Similarly, in 2012, overall fraud risk declined 4.7%, as the mortgage rate declined from 3.9% to 3.6% between the first quarter of 2012 and fourth quarter of 2012 and the share of refinances increased from 68% to 72%.”

According to First American’s report, the Defect Index for refinance transactions decreased by 4.2% in July, holding steady from 2018’s rate. Fleming says this decline is directly related to the market’s low-interest rate environment.

“The prevailing mortgage rate of 3.8% in July triggered a 25% jump in refinances month over month and a 60% jump compared with July 2018,” Fleming said. “Why does this matter for fraud risk? Defect, fraud and misrepresentation risk is significantly lower on refinance transactions, so the reduced risk of fraud and misrepresentation in July is largely due to the increasing share of lower risk refinance transactions within the mortgage market.”

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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