Lower mortgage application fraud risk persists with buyer's market

The switch to a buyer's home purchase market, as well as fewer natural disasters helped drive the five-month-long decline in mortgage application fraud risk, First American said.

August's First American Loan Defect Application Index dropped to 73, down 3.9% from 76 in July and 5.2% from 77 in August 2018. The index now sits at its lowest level since January 2017, and fell 22 points since its most recent peak in March.

But between July 2018 and February 2019, the index rose 25% going from 76 to 96.

"And then, it stopped. In the second half of 2018, rising mortgage rates reduced the share of refinance transactions, leading to a greater share of higher-risk purchase transactions," said First American Chief Economist Mark Fleming.

"Additionally, hurricanes and wildfires in the second half of 2018 contributed to climbing defect risk. Our research indicates natural disasters go hand-in-hand with rising loan application defect risk, as natural disasters create greater opportunity for misrepresentation of collateral condition. But, 2019 provided a fresh start."

The first eight months of 2019 came with fewer natural disasters, lower interest rates, increased household income and more homes for sale — although inventory remains tight, Fleming noted. All those factors boosted house buying power and shifted the purchase market dynamics back toward the buyers.

That shift provided less incentive for purchasers to make misrepresentations on their mortgage loan application in order to buy a home.

August's purchase index of 77 is an all-time low; the previous low of 79 was reached on several occasions, most recently in August 2018.

In addition, the increase in refinance mortgage loan applications — which are inherently less risky than purchases — contributed to the index's decline. This is a turnaround from a year ago, when rising mortgage rates contributed to the spike.

The refi index of 66 was three points lower than July's and for August 2018. But it was nowhere near the all-time low of 56 for November 2016. The all-time low for the overall index was 68 in both October and November 2016.

Although these conditions led to lower application fraud risk so far this year, Fleming was concerned that those same factors could lead to another turn-around.

"While inventory has made some gains, it has mostly been for higher-priced homes. The supply for lower- and middle-priced homes remains tight," he said.

"Increasing demand against limited supply means that the housing market could be poised for another strong sellers' market, which could create a spike in fraud risk. The good news is that mortgage rates fell further in September, indicating even more refinances may be on the way," said Fleming. "Stronger buyers' market conditions and a rising share of refinance transactions — that's what we need to maintain declining fraud risk momentum in 2019."