Strong home buying season boosts mortgage defect risk: First American

A strong spring home purchase season is likely to further increase mortgage loan application defect risk, which already spiked in the past two months, according to First American.

In January, the First American Loan Application Defect Index rose four points from December to 91, the highest it has been since July 2014. The index was 83 for January 2018.

"The overall rise in purchase and refinance applications, coupled with strong first-time homebuyer demand and tight inventory, bodes well for an early spring home buying season, but may contribute to further increases in defect risk. Historically, purchase transactions tend to be more at risk of defects, fraud and misrepresentation, and the pressures resulting from rising demand and a strong sellers' market compounds that risk," Mark Fleming, First American's chief economist, said in a press release.

"When home values are rising and the housing market is competitive, more buyers want to enter in the market. As a result, misrepresentation and fraud are more likely on a loan application."

The overall fraud index has been on the rise since July 2018, but that was partially due to natural disasters and can only explain the rise through November, he said. The 10-point increase over the past two months is likely a result of the decline in interest rates in December and January.

"Prospective homebuyers and existing homeowners reacted to the lower rates, resulting in a mini-boom in mortgage applications, both purchase and refinance," said Fleming. Refinance applications have a lower fraud risk than purchases. "As mortgage rates rise, fewer people refinance, so the share of less risky refinance loan transactions decreases and the share of more risky purchase transactions increases," he said.

Because falling rates created an increase in both application types, "the forces driving the acceleration in fraud risk over the last two months are a little less clear," Fleming said.

The purchase defect index rose five points from December to 95 and is now at its highest since October 2014. There was a four-point increase in the refinance increase index to 83. This index is at its highest since April 2015.