Lower rates have helped cut defect risk says First American

A leading estimate of the risk of defects, fraudulence, and misrepresentations in mortgage applications has finally moved lower.

The First American Loan Application Defect Index was 4.2% lower in April than the previous month, the first decline in eight months. It was however, 11.0% higher than April 2018.

Mark Fleming, chief economist at First American, says lower mortgage rates helped cut the risk.

“Decreasing mortgage rates contributed to an increase in inventory, reducing the competitive pressure on the housing market, as well as contributing to an increase in lower-risk refinance transactions. In line with this trend, the Loan Application Defect Index for purchase transactions declined for the first time in eight months, falling 4.0 percent in April compared with the previous month.”

There was also a decline in risk for refinance applications (3.5%) but the year-over-year figures show an increase of 16.9% (10.3% for purchase apps).

“The two competing trends that resulted in a flat fraud risk last month were the increasing share of less risky refinance transactions working to decrease overall fraud risk, and the continuation of the hot sellers’ market, motivating buyers to misrepresent information in order to qualify for a bigger mortgage and increase overall fraud risk,” said Fleming.

Lower competition

There was a rise in purchase applications in April but despite their higher propensity for fraud and misrepresentations, there was another factor in play.

“The decline in mortgage rates had a third and even more important consequence, which was to help alleviate some of the supply constraints that made the housing market so competitive,” said Fleming. “As we saw in last month’s report, in extremely competitive markets, there is more motivation to misrepresent information on a loan application to qualify for the bigger mortgage in order to win the bidding war.”

Fleming says that the future of misrepresentation and fraud risk is closely tied to mortgages rates.

“It remains to be seen if mortgage rates, now flirting with 4%, will go any lower. If so, we may anticipate the continued downward trend in defect risk and misrepresentation, with further increases in refinance transactions and inventory, resulting in less pressure on the market,” he concluded.