Falling Refis, Rising ARMs Spell Increased Defect Risk For Mortgage Lenders

Posted by Patrick Barnard on March 24, 2017 No Comments
Categories : Residential Mortgage

The risk of defects in mortgage applications increased 4.1% in February compared with January and increased 1.3% compared with February 2016, according to First American’s Loan Application Defect Index.

The increase is due, in part, to the decrease in applications for refinances. As the share of applications for purchases increases, so does the risk of defects because applications for purchases tend to be more prone to errors and misstatements.

Still, the overall risk of defects was down 25.5% from the high point of risk in October 2013.

The risk of defects in applications for refinances in February increased 3.4% compared with January but was down 6.2% compared with February 2016.

The risk of defects in applications for purchases increased 2.4% compared to the previous month and was up 2.4% compared to a year ago.

The ongoing shift to a purchase market – in addition to the potential for more adjustable rate mortgages (ARMs) – means mortgage lenders should remain watchful for defect and fraud risk, says Mark Fleming, chief economist for First American.

“This month, the Loan Application Defect Index surged higher as rising mortgage rates continue to put downward pressure on lower risk mortgage refinance activity,” Fleming says in a statement. “The March rate increase by the Federal Open Market Committee and strong economic performance will continue to pressure rates upward.

So why would there be more applications for ARMs in this rising rate environment?

“The savings for the consumer can be significant,” Fleming says.

However, “ARM loan applications have historically had higher defect, misrepresentation and fraud risk,” he adds.

“The increasing popularity of ARMs is something to keep an eye on as the spring home buying season warms up,” he says.

Whether borrowers will continue to seek affordability by switching from 30-year, fixed-rate mortgages to less expensive ARMs remains to be seen.

“The 5/1 ARM averaged 3.2 percent in February, almost a full percentage point less than the traditional fixed-rate mortgage,” Fleming says. “According to the Mortgage Bankers Association Application survey, the share of ARM applications reached its highest level in over a year at 7.5 percent of total applications.”

As a result, during the last three months, “loan application, defect and fraud risk has increased by 5.6 percent on ARM loan applications,” Fleming says.

“While there is no significant difference in risk between ARMs and fixed-rate mortgages today, historically ARM loan applications have been the riskier loan product type,” he adds.

For more, including a breakdown of fraud risk by state, click here.

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