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The Re-emergence of Loan Defects

home-in-your-handsFor a while, loan defects had settled down in the mortgage industry, but they appear to be making their way back into the market due to heightened risk from government loans.

First American Financial Corporation's Loan Application Defect Index released Thursday rose 1.3 percent in March but remains 2.6 percent lower than a year ago. The index rose in March for the first time since July 2015, ending seven consecutive months of declining defect and misrepresentation risk, but is now down 25.5 percent from the high point of risk in October 2013.

In February, the defect index declined for the seventh consecutive month by 1.3 percent in February 2016 compared to January and is down 5.1 percent year-over-year. The defect index now stands at 76, the lowest it has been since inception.

According to First American, the index value is based on the frequency with which defect indicators are identified, and it moves higher as greater numbers of defect indicators are identified. An increase in the index indicates a rising level of loan application defects. The index, nationally and in all markets, is benchmarked to a value of 100 in January 2011. Therefore, all index values can be interpreted as the percentage change in defect frequency relative to the defect frequency identified nationally in January 2011.

“While February 2016 is now the new low point for the index, it’s too early to know if the increase in misrepresentation and fraud risk in March is the beginning of a long-term upward trend or a short-term adjustment. One possibility for the reversal of direction is the month-over-month increase in risk among Federal Housing Administration (FHA), Veterans Administration, and United States Department of Agriculture loans,” said Mark Fleming, Chief Economist at First American.

He continued, "The defect risk for these loan transaction types increased 1.4 percent from February to March, as opposed to conventional loans that had no change month-over-month. The share of FHA mortgage originations increased after a reduction in the premium last year, making them relatively more competitive for borrowers with low down payments and low credit scores, which also typically have higher defect risk.”

Refinance transaction defects increased 1.5 percent month-over-month, and is now 5.7 percent lower than a year ago, according to the report. Meanwhile, the index for purchase transactions increased 1.2 percent in March, and is down 3.4 percent compared to a year ago.

“While loan application and mortgage risk increased modestly this month, risk remains significantly lower than a year ago and is significantly lower than it’s been in the last five years,” Fleming stated. “Improved loan manufacturing compliance, underwriting consistency and risk management are finally paying off for the industry with less defect, misrepresentation and fraud risk.”

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About Author: Xhevrije West

Xhevrije West is a talented writer and editor based in Dallas, Texas. She has worked for a number of publications including The Syracuse New Times, Dallas Flow Magazine, and Bellwethr Magazine. She completed her Bachelors at Alcorn State University and went on to complete her Masters at Syracuse University.

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