The index shows that the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications decreased by 3.9% compared with the previous month. Compared to August 2018, the Defect Index decreased by 5.2%. The Defect Index is down 28.3% from the high point of risk in October 2013.
The Defect Index for refinance transactions decreased by 4.3% compared with the previous month, and decreased by 4.3% compared with a year ago. The Defect Index for purchase transactions decreased by 3.8% compared with the previous month, and is down 2.5% compared with a year ago.
“Declining for the fifth consecutive month, the Loan Application Defect Index for purchase transactions continued its downward trend, falling 3.8% in August compared with July. The Defect Index for refinance transactions also fell, declining 4.3% compared with the previous month,” said Mark Fleming, chief economist at First American. “The overall Defect Index, which includes both purchase and refinance transactions, fell 3.9% compared with last month, and is 5.2% lower than one year ago.
“The overall Defect Index has not been this low since January 2017. However, falling defect risk is a recent phenomenon,” said Fleming. “In late 2018 and early 2019, overall defect risk rose at a fast pace and continued to do so until reaching a peak in February 2019. So, what sparked the slide in fraud risk in 2019?”
Why is 2019 Different?
“Between July 2018 and February 2019, the overall Defect Index increased 25%. And then, it stopped. In the second half of 2018, rising mortgage rates reduced the share of refinance transactions, leading to a greater share of higher-risk purchase transactions. Additionally, hurricanes and wildfires in the second half of 2018 contributed to climbing defect risk,” said Fleming. “Our research indicates natural disasters go hand-in-hand with rising loan application defect risk, as natural disasters create greater opportunity for misrepresentation of collateral condition. But, 2019 provided a fresh start. In addition to fewer natural disasters, there are two primary reasons why 2019 has been the year of declining fraud risk.”
Market Dynamics Shift Toward Buyers
“Following the strong sellers’ market conditions throughout 2018, market dynamics shifted slightly toward buyers in 2019. Mortgage rates began to decline in January 2019 and are 0.8 percentage points lower in August than January,” said Fleming. “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."
“House-buying power gains and improvements in inventory tilt the market toward the buyer. But, what is the connection to fraud risk? Potential home buyers feel less pressure to misrepresent information on a loan application when strong sellers’ market conditions wane, as the market is less competitive,” said Fleming.
Increase in the Share of Refinances
“For many homeowners, the most important consideration when deciding to refinance is whether the mortgage rate is sufficiently lower than their existing rate. The 30-year, fixed-rate mortgage in August averaged 3.6%, the lowest since October 2016,” said Fleming. “According to estimates, 11.6 million existing households would be refinancing candidates at a mortgage rate of 3.5%, compared with just 2.9 million households when the mortgage rate is 4.5%.
“As a result of lower rates, refinance applications are up 148 percent compared with one year ago, according to the latest MBA mortgage applications survey,” said Fleming. “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.”
Will Buyers’ or Sellers’ Market Conditions Change Fraud Risk Outlook?
“Housing market conditions and fewer natural disasters have created a declining fraud risk environment in 2019, so far. However, lower mortgage rates and higher incomes typically result in more demand for homes,” said Fleming. “While inventory has made some gains, it has mostly been for higher priced homes. The supply for lower- and middle-priced homes remains tight.
“Increasing demand against limited supply means that the housing market could be poised for another strong sellers’ market, which could create a spike in fraud risk. The good news is that mortgage rates fell further in September, indicating even more refinances may be on the way,” said Fleming. “Stronger buyers’ market conditions and a rising share of refinance transactions – that’s what we need to maintain declining fraud risk momentum in 2019.”
