Loan defect risk eases as lower rates boost refinance activity

The current trajectory of mortgage rates is boosting refinancing activity which means a lower risk of defects, fraud, and misrepresentations in mortgage applications.

First American’s Loan Application Defect Index fell 5% in July compared with the previous month, although it remains the same as in July 2018. For refinances, the index declined 4.2% month-over-month but remained the same as a year earlier; for purchases it decreased 3.6% but increased 1.3% year-over-year.

“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,” said First American’s chief economist Mark Fleming.

He explained that the prevailing mortgage rate of 3.8% in July triggered a 25-percent jump in refinances month over month and a 60-percent jump compared with July 2018.

“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,” said Fleming.

Continued decline in defect risk

This scenario has been seen in previous refinance booms and Fleming says the rise of refi activity is likely to continue.

“The 30-year, fixed mortgage rate continued to decline in August, which is likely to boost refinance demand even further,” said Fleming. “In fact, according to estimates, the number of existing households that would be refinance candidates would increase to 11.6 million at a mortgage rate of 3.5% (as the prevailing rate would be at least 0.75 percentage point lower than their current rate), compared with just 2.9 million households when the mortgage rate is 4.5%. As the mortgage market composition continues to shift toward refinance transactions in 2019, the risk of defect, fraud and misrepresentation will continue to decline.”

State, market highlights in July 2019

• The five states with a year-over-year increase in defect frequency are: Nebraska (+34.8 percent), Iowa (+25.0 percent), New York (+19.7 percent), Rhode Island (+13.4 percent), and Pennsylvania (+13.3 percent).
• The five states with a year-over-year decrease in defect frequency are: Florida (-11.2 percent), Vermont (-9.9 percent), Arkansas (-7.7 percent), Arizona (-6.8 percent), and Texas (-6.3 percent).
• Among the largest 50 Core Based Statistical Areas (CBSAs), the five markets with the greatest year-over-year increase in defect frequency are: Buffalo, N.Y. (+20.3 percent), Pittsburgh (+15.5 percent), Kansas City, Mo. (+12.5 percent), San Jose, Calif. (+11.9 percent), and New York (+11.8 percent).
• Among the largest 50 Core Based Statistical Areas (CBSAs), the three markets with a year-over-year decrease in defect frequency are: Houston (-19.1 percent), Jacksonville, Fla. (-17.0 percent), Orlando, Fla. (-16.5 percent), San Diego (-16.5 percent), and Tampa, Fla. (-14.0 percent).