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TH E M R EP O RT | 45 O R I G I NAT I O N S E R V I C I N G A NA LY T I C S S E C O N DA R Y M A R K E T ORIGINATION THE LATEST Ability-to-Repay Rule Drives Loan Defects Down Loan defects, fraudulence, and misrepresentations are on the decline, falling more than 20 percent since their height. M ortgage loan application defects are becoming less prevalent in the housing market as the ability-to- repay rules are reducing fraud risk related to income, while misrepresented income is more likely to be caught on a loan application. First American Financial Corp., a global provider of title insurance, settlement services, and risk solutions for real estate transactions, released its Loan Application Defect Index in November. The index declined by 2.5 percent in October 2015 compared to September 2015. The index, which estimates the frequency of defects, fraudulence, and misrepresentation in the information submitted in mortgage loan applications is also down 10.2 percent year-over-year and down 22.3 percent from the height of fraud risk in October 2013. "Fraudulent and misrepresenta - tive loan applications are continu- ing to decline, as our risk index is trending toward the lowest point we have recorded in the last five years. The reduction in risk is occurring across property type, occupancy, loan purpose, and whether a conforming con - ventional or FHA, VA, USDA loan," said Mark Fleming, Chief Economist at First American. "While risk is declining overall, there are still categories of loans that are riskier. In particular, self- reported investor, ARM, purchase, and multi-unit transactions have heightened defect, fraud, and misrepresentation risk." October marked the third month of a greater than 6 per - cent decline in mortgage loan application defects and risk, First American stated. However, the index remains 1.3 percent above the low point set in March 2015. Refinance defects decreased 2.8 percent month-over-month and are down 10.4 percent year-over-year, the data showed. The Defect Index for purchase transactions fell 2.3 percent month-over-month and is down 10.5 percent year-over-year. Five states with the highest month-over-month increase or smallest decrease in defect fre - quency are: • North Dakota (+3.3 percent) • Alaska (+0.0 percent) • Iowa (+0.0 percent) • Missouri (+0.0 percent) • Illinois (-1.3 percent) Five states with the highest month-over-month decrease in defect frequency are: • Michigan (-6.1 percent) • Vermont (-5.2 percent) • California (-4.9 percent) • Louisiana (-4.9 percent) • Connecticut (-4.8 percent) First American also reviewed two additional risk categories in October: employment and income defect, fraud, and misrepresenta- tion, finding that employment- related defects and potential misrepresentation has been stable, but recently increased, while income misrepresentation has trended downward since the end of 2012. "One of the clearest benefits of more stringent underwriting stan - dards related to the ability of a borrower to sustainably pay their mortgage can clearly be seen in the improvement in the income- specific defect risk index. Income- related defect, misrepresentation and fraud risk is down 49 percent from its peak in December 2012," Fleming explained. "Given the heightened scrutiny of a bor - rower's ability to pay, intentionally misrepresenting one's income for fraudulent gain is more likely to get caught." When questioned about how the rate hike will af- fect the housing market, Mike Hardwick, Founder and President of Churchill Mortgage said in an interview that this will motivate "on the fence" buyers to move forward with purchasing a home. "The Fed only raised rates a quarter of a percent," Hardwick said. "Moving the rates up too fast could really spook the markets and who knows what that would mean; it could really cause an overall economy stall, but I don't think they will do that." President and CEO, United Wholesale Mortgage Mat Ishbia also agreed that the Fed's decision will be a positive change in the industry. "Consumers that have been on the fence about moving forward will now be more likely to make a move," Ishbia noted. "I do believe that purchase busi - ness is going to increase in 2016, while refinances will decline and adjustable rate mortgages (ARMs) will become a bigger part of business for loan officers. It's imperative for people in the mortgage industry to educate themselves on the benefits of ARMs and to align themselves with real estate agents." Steve Hovland, Director of Research at HomeUnion told MReport in an interview that homeownership will be a rare commodity next year as a result of the Fed's decision to raise rates. "Unlike previous meetings, the Fed strongly prepped the markets for this change in monetary policy, which pushed up average 30-year mortgage rates 20 basis points, and the 10-year Treasury 25 basis points over the past few weeks. We don't expect mortgage rates to move up in-step with the funds rate, though homeowner - ship will be further out of reach for many renters. At 63.7 percent, the homeownership rate is near a 30-year low and will likely fall further in 2016." The first FOMC meeting of 2016 will take place January 26-27. Note: The Five Star Institute is the parent company of the MReport and theMReport.com.