Market Overview

Loan Application Defect Risk in Adjustable-Rate Mortgages Slips Below Fixed-Rate Mortgages, According to First American's Loan Application Defect Index

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—Today's ARM is not like those of the past. It is essentially the
same as the 30-year, fixed-rate mortgage with one difference – rates
adjust after an initial fixed period of usually five or seven years,
says Chief Economist Mark Fleming—

First
American Financial Corporation
(NYSE:FAF), a leading
global provider of title insurance, settlement services and risk
solutions for real estate transactions, today released the First
American Loan Application Defect Index
for February 2018, which
estimates the frequency of defects, fraudulence and misrepresentation in
the information submitted in mortgage loan applications. The Defect
Index reflects estimated mortgage loan defect rates over time, by
geography and loan type. It is available as an interactive
tool
that can be tailored to showcase trends by category, including
amortization type, lien position, loan purpose, property and transaction
types, and can provide state- and market-specific comparisons of
mortgage loan defect levels.

February 2018 Loan Application Defect Index

  • The frequency of defects, fraudulence and misrepresentation in the
    information submitted in mortgage loan applications remained the same
    compared with the previous month.
  • Compared to February 2017, the Defect Index increased by 9.2 percent.
  • The Defect Index is down 18.6 percent from the high point of risk in
    October 2013.
  • The Defect Index for refinance transactions remained unchanged
    compared to the previous month and is 13.1 percent higher than a year
    ago.
  • The Defect Index for purchase transactions decreased by 1.1 percent
    compared with the previous month and is up 7.1 percent compared with a
    year ago.

Chief Economist Analysis: Will the Return of ARMs Lead to Surging
Loan App Defect Risk?

"It's been a long time coming – a rising rate environment. The 30-year,
fixed-rate mortgage has been below 4.5 percent since late 2013 and is
now finally moving consistently higher. According to the consensus of
economic forecasts, it is likely to approach 5 percent by the end of
this year," said Mark Fleming, chief economist at First American. "This
matters for defect, fraud and misrepresentation risk as rising mortgage
rates reduce the benefit of refinancing and increase the share of
purchase loan transactions in the market. As we have noted
before
, purchase loan transactions are riskier than refinance
transactions.

"But, there is another reason why a rising rate environment matters for
defect, fraud and misrepresentation risk. The allure of the
adjustable-rate mortgage (ARM) increases," said Fleming. "The current
rate on a 30-year, fixed-rate mortgage is approximately 4.5 percent.
Yet, there is another mortgage option – the ARM, which typically has a
lower rate than the traditional 30-year, fixed-rate mortgage. Currently,
ARMs are available at about 4 percent. As rates increase and borrowers
seek to keep their monthly payment low, more borrowers are likely to
choose the adjustable-rate option."

A Kinder, Gentler, Less Risky ARM

"ARMs historically have had more defect, fraud and misrepresentation
risk than the traditional 30-year, fixed rate mortgage," said Fleming.
"Interestingly, that has changed recently. ARMs, based on our defect,
fraud and misrepresentation index, are modestly less risky.

"At the height of the housing boom, ARMs were all the rage, and many
included additional elements that added risk, such as negative
amortization, payment-option and interest-only options, and teaser rate
ARMs. Today's ARM is not like those of the past," said Fleming. "It is
essentially the same as the 30-year, fixed-rate mortgage with one
difference – rates adjust after an initial fixed period of usually five
or seven years. Saving half a percent on the mortgage rate may be
worthwhile for many consumers, especially if their expected tenure
length in the house is not 30 years.

"As mortgage rates continue to rise, the share of ARMs is also likely to
increase and, if current defect risk patterns hold, will offset some of
the increased risk the market will bear as it shifts to purchase
transactions."

February 2018 State Highlights

  • The five states with the greatest year-over-year increase
    in defect frequency are: South Dakota (+28.2 percent), Wyoming
    (+20.5 percent), New Mexico (+19.4 percent), Oregon (+18.6 percent)
    and Delaware (+18.5 percent).
  • There are three states with a year-over-year decrease
    in defect frequency: Louisiana (-9.8 percent), Connecticut (-5.6
    percent) and Minnesota (-5.0 percent).

February 2018 Local Market Highlights

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five
    markets with the greatest year-over-year increase
    in defect frequency are: Virginia Beach, Va. (+24.3 percent), Oklahoma
    City (+22.7 percent), Portland, Ore. (+21.2 percent), Los Angeles
    (+20.0 percent), and Cleveland (+18.8 percent).
  • Among the largest 50 Core Based Statistical Areas (CBSAs), the five
    markets with the largest year-over-year decrease
    in defect frequency are: Minneapolis (-7.5 percent), Austin, Texas
    (-4.9 percent), Raleigh, N.C. (-4.8 percent), Hartford, Conn. (-1.5
    percent), and Pittsburgh (-1.5 percent).

Next Release

The next release of the First American Loan Application Defect Index
will take place the week of April 23, 2018.

Methodology

The methodology statement for the First American Loan Application Defect
Index is available at http://www.firstam.com/economics/defect-index.

Disclaimer

Opinions, estimates, forecasts and other views contained in this page
are those of First American's chief economist, do not necessarily
represent the views of First American or its management, should not be
construed as indicating First American's business prospects or expected
results, and are subject to change without notice. Although the First
American Economics team attempts to provide reliable, useful
information, it does not guarantee that the information is accurate,
current or suitable for any particular purpose. © 2018 by First
American. Information from this page may be used with proper attribution.

About First American

First American Financial Corporation (NYSE:FAF) is a leading
provider of title insurance, settlement services and risk solutions for
real estate transactions that traces its heritage back to 1889. First
American also provides title plant management services; title and other
real property records and images; valuation products and services; home
warranty products; property and casualty insurance; and banking, trust
and wealth management services. With total revenue of $5.8 billion in
2017, the company offers its products and services directly and through
its agents throughout the United States and abroad. In 2018, First
American was named to the Fortune 100 Best Companies to Work
For® list for the third consecutive year. More information
about the company can be found at www.firstam.com.

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