The risk of fraud on purchase-mortgage transactions rose last month for the first time since the end of first-quarter 2019, according to November’s loan application defect index from First American Financial Corp.
The overarching index, which tracks the frequency of defects, fraudulence and misrepresentation across all mortgage loan applications, stayed flat on a month-over-month basis. The component index for purchase transactions, however, saw its reading increase from October to November, although it is still down 8.3% compared to one year ago.
“As we predicted last month, the Loan Application Defect Index for purchase transactions reached a turning point in November,” said Mark Fleming, First American’s chief economist. “After falling since March, the Defect Index for purchase transactions increased 2.7 percent compared with October, while the Defect Index for refinance transactions fell by 1.6 percent, its eighth straight month of declining risk.”
The refinance index decreased by 17.8% annually last month, helping to drive a year-over-year decrease of 16% for the overall loan-defect index. The overall index is now down 33.3% from its high point in October 2013.
Until November, loan-defect risk had been falling on a monthly basis since this past March. The reason for the shift is twofold, Fleming explained.
“When house-buying power — i.e., how much home one can buy based on changes in household income and interest rates — falls in a supply-constrained market, fraud risk may increase,” Fleming said. “Potential homebuyers feel more confident and less inclined to commit fraud when they are in a better financial position to purchase a home.”
And although homebuying power remains strong, the pace of its growth slowed this past October when mortgage rates began to inch up.
“In 2019, the average monthly growth rate of house-buying power through September was 1.6 percent. Over the two months of October and November combined, house-buying power declined 0.6 percent relative to September,” Fleming said. “The slowdown in house-buying power appreciation lessens the confidence of homebuyers, so they may be more inclined to misrepresent information on a loan application, leading to an increase in the Defect Index for purchase transactions.”
In October 2019, purchase-loan activity grew 7% compared to one year earlier. And as rates continue to hold firm and the refi boom appears to have plateaued, refinance activity fell 8% annually during the same month. Fraud and defect risk are significantly lower on refinance transactions, so the increase in purchase mortgages helped to precipitate the upward swing in risk.
Moving into 2020, any further effects of rate changes will be interesting to observe, Fleming added.
“Slightly higher mortgage rates through the end of the year may result in a small dip in house-buying power and a further pullback in refinance demand,” he said. “But, looking ahead to 2020, mortgage rates are expected to remain below 4 percent,” he said. “At that level, there are still 6.8 million borrowers today who could benefit financially by refinancing to a lower mortgage rate. As a result, the direction of defect risk in 2020 is in large part dependent on mortgage rates and how many homeowners that are ‘in the money’ choose to refinance.”
