As both origination volume and interest rates increased during the second quarter, mortgage defect rates rose too, increasing by nearly 15% compared with the first quarter, Aces Quality Management said.
This marks the second consecutive quarter where defect rates were higher. That, along with the fact they are inching up back to the 2% level, is troubling, the accompanying report said.
Defects were over 2% for six of the eight quarters between the third quarter of 2020 and third quarter of 2022. These are potential red flag indicators for, but not necessarily proof of, mortgage fraud.
The total rate of 1.81% was 23 basis points higher than for the first quarter, when it was 1.58%. It was also an increase over the second quarter of 2023, when the rate was 1.78%.
“This quarter’s rise in critical defects signals that lenders need to double down on quality control efforts, especially as volumes grow,” said Nick Volpe, executive vice president at Aces, in a press release.
“While the industry’s resilience is evident, the increased scrutiny of income and other key underwriting areas reminds us of the complexities in today’s lending landscape,” he continued. “Proactive adoption of digital tools is key to maintaining high standards and navigating an environment where even minor lapses can impact long-term performance.”
The single largest category of defects was related to income and employment, but they rose over 58% compared with the first quarter, to 37.01% from 23.42%.
While the share of appraisal defects was the sixth most cited category, they almost doubled versus the first quarter, to 7.14% from 3.6%.
Aces noted appraisals are always an area of interest when it comes to looking at loan manufacturing errors.
“After Q3 2022’s low of 2.74%, appraisal defects have averaged around 3.96%, which makes Q2’s 7.14% share somewhat concerning,” the report added.
Aces uses the Fannie Mae defect taxonomy to categories loan manufacturing errors.
Of the total production volume Aces reviewed, 91.13% of the loans were for a home purchase and 8.87% were refinances. The company found defects in 83.33% of purchase mortgages and 16.67% in refi applications.
By product type, both conventional and mortgages the Federal Housing Administration insured had an outsized percentage of defects relative to their share of originations.
Conventional mortgages made up 60.74% of the file reviews but had 66.44% of the defects. The equivalent numbers for FHA loans were 19.54% and 22.6% respectively.
But the quality of Veterans Affairs-guaranteed loans remained strong. They constituted 17.7% of reviews Aces studied, but just 8.9% of defect findings.
U.S. Department of Agriculture program mortgages had a defect share equal to their review percentage at just above 2% for the total universe.
But individually, USDA loans, largely because of their small number of mortgages produced in the overall market, had an increase in the defect share of 370.9% versus the first quarter.
On a quarter-to-quarter basis, lenders saw performance improve for FHA loans by 35.26% and VA loans by 56.57%, while the conventional defect share increased by 13.59%.
“However, any increase in defects should be a signal to lenders that extra vigilance is needed to ensure momentary do not turn into long-term trends,” the report said.
