Mortgage Loan Application Defects Driven Lower by Ability-to-Pay Rules

Mortgage loan application defects are becoming less prevalent in the housing market as the Ability-to-Pay rules are reducing fraud risk related to income, while misrepresented income is more likely to be caught on a loan application.

First American Financial Corp., a global provider of title insurance, settlement services, and risk solutions for real estate transactions released their Loan Application Defect Index Tuesday, which declined by 2.5 percent in October 2015 compared to September 2015.

The index, which estimates the frequency of defects, fraudulence, and misrepresentation in the information submitted in mortgage loan applications is also down 10.2 percent year-over-year and down 22.3 percent the height of fraud risk in October 2013.

“Fraudulent and misrepresentative loan applications are continuing to decline, as our risk index is trending toward the lowest point we have recorded in the last five years. The reduction in risk is occurring across property type, occupancy, loan purpose, and whether a conforming conventional or FHA, VA, USDA loan,” said Mark Fleming, Chief Economist at First American. “While risk is declining overall, there are still categories of loans that are riskier. In particular, self-reported investor, ARM, purchase, and multi-unit transactions have heightened defect, fraud, and misrepresentation risk.”

October will mark the third month of decline in mortgage loan application defects and risk, in which the index has declined over 6 percent, First American stated. However, the index remains 1.3 percent above the low point set in March 2015.

Refinance defects decreased 2.8 percent month-over-month, and down 10.4 percent year-over-year, the data showed. The Defect Index for purchase transactions fell 2.3 percent month-over-month, and is down 10.5 percent year-over-year.

First American's Top Five States With the Highest Month-Over-Month INCREASE or SMALLEST Decrease in Defect Frequency are:

1. North Dakota (+3.3 percent)
2. Alaska (+0.0 percent)
3. Iowa (+0.0 percent)
4. Missouri (+0.0 percent)
5. Illinois (-1.3 percent)

First American's Top Five States with the Highest Month-Over-Month DECREASE in Defect Frequency are:

1. Michigan (-6.1 percent)
2. Vermont (-5.2 percent)
3. California (-4.9 percent)
4. Louisiana (-4.9 percent)
5. Connecticut (-4.8 percent)

First American also reviewed two additional risk categories in October: Employment and Income Defect, Fraud, and Misrepresentation, finding that employment-related defects and potential misrepresentation has been stable, but recently increased, while income misrepresentation has trended downward since the end of 2012.

“One of the clearest benefits of more stringent underwriting standards related to the ability of a borrower to sustainably pay their mortgage can clearly be seen in the improvement in the income-specific defect risk index. Income-related defect, misrepresentation and fraud risk is down 49 percent from its peak in December 2012,” Fleming explained. “Given the heightened scrutiny of a borrower’s ability to pay, intentionally misrepresenting one’s income for fraudulent gain is more likely to get caught.”

Click here to view the full report.