Application defect risk remained flat in July

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Loan application defects were unchanged for July compared with June, the first time in eight months there has not been an increase, according to First American Financial Corp.

For all applications, the First American Loan Application defect risk index remained at 84, but that is still its highest level since July 2015.

"Finally, after seven consecutive months of increasing defect, fraud and misrepresentation risk, no change compared to last month is welcome news," said First American Chief Economist Mark Fleming in a press release.

"In particular, purchase transactions, which are inherently more at risk of defects, fraud and misrepresentation, showed no increase compared to a month ago. One month doesn't establish a trend, so it will be important to see if we've reached a turning point in the long-run trend of increasing defect risk."

The purchase loan defect index remained at 91, while for refinance loans it increased to 71 from 70.

In July 2016, the overall index was at 70, on its way down to an all-time low of 68 for both October and November.
Defects and misrepresentations are an indicator of fraud connected with the mortgage application.

The Federal Open Market Committee is expected to start unwinding the Federal Reserve's balance sheet in September and that could push up mortgage rates.

"Historically, when mortgage rates increase, more borrowers consider adjustable-rate mortgages with lower rates instead of more traditional fixed-rate mortgages to maintain purchasing power," said Fleming. An ARM can be a good alternative to a fixed-rate mortgage in a rising rate environment, but they have historically had more fraud and misrepresentation risk."

Prior to this year, ARMs have been significantly riskier than FRMs. July's index for ARMs is at 102, while for FRMs it is at 101, compared with 89 and 84, respectively, last November.

"In 2017, while risk has been increasing for both loan types, fixed-rate mortgage risk has closed the gap. Currently, the defect risk for both adjustable- and fixed-rate mortgages is approximately the same," he said. Therefore the Fed's actions won't impact loan defect risk.

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