The defect rate for mortgages grew significantly across all loan types in the second quarter of 2024, continuing a trend seen in the first quarter. The share of loans with defects grew to 1.81%, according to a recent report released Wednesday by ACES Quality Management.
The Denver-based quality control company compiles a quarterly report that is derived from post-closing quality control data gathered by the company’s benchmarking software. Adjustments are made to reflect trends from prior quarters and years. Lender-selected loan audits were the primary data source for the Q2 2024 report.
Critical defects were found in 1.81% of all loans in the second quarter. That’s up from 1.58% in Q1 2024, representing an increase of 14.56%. This growth follows a recent trend, although the defect rate rose by only 3.27% between Q4 2023 and Q1 2024. Income and employment data continues to lead all defect categories with a share of 37.01% — up 58% from the first quarter.
‘Baffling’ increases
ACES called the consistent increase in income and employment data defects “baffling, especially as the GSEs — Freddie Mac in particular — continue to penalize lenders for income errors.” The report notes that Freddie Mac’s loan repurchase volume grew 29% to $430 million in Q2 2024, primarily due to income verification defects. ACES remains hopeful that new tools from the government-sponsored enterprises will correct these issues.
“Given the relative ‘newness’ of some of these initiatives compared to this quarter’s data, it is our hope and expectation that income/employment defects will improve as lenders take advantage of these tools and initiatives,” the report stated.
All four major defect categories — income and employment, assets, liabilities and credit —saw an increase in Q2. From a sub-category perspective, asset-based defects stemming from calculation and analysis problems skyrocketed by 373% from Q1. Credit defects mainly were caused by a 4.76% increase in eligibility defects, although ACES describes this as “moderate” compared to the 40% increase in the same category for the prior quarter.
Beyond the major underwriting categories, appraisal defects nearly doubled to encompass 7.14% of all loans in Q2 2024.
Insurance defects declined by 92%, while legal, regulatory and compliance defects dropped by 64%. Loan documentation defects were down 41%, representing the few positives in the report.
ACES: Lenders need to buckle down
By loan type, purchase reviews were most common, explaining the rise in purchase loan defects (up 2.71%). Refinance defects dropped by 11.66%. Lenders focused mainly on purchase loan reviews (91.13%) compared to the first quarter (87.55%).
The review and defect shares for Federal Housing Administration (FHA) and conventional loans declined in Q2. Lenders instead focused on U.S. Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans. FHA and VA loan performance improved, while conventional and USDA performance declined, which the report describes as an “outsized impact” compared to other findings.
Nick Volpe, executive vice president for ACES Quality Management, said that Q2 defects show that lenders need to buckle down on quality control.
“This quarter’s rise in critical defects signals that lenders need to double down on quality control efforts, especially as volumes grow,” Volpe cautioned. “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.”
Volpe said that lenders must rely on digital tools to lessen defect rates.
“Proactive adoption of digital tools is key to maintaining high standards and navigating an environment where even minor lapses can impact long-term performance,” he said. “This period reflects an industry balancing operational pressures with rigorous compliance demands, underscoring the value of a robust QC program to identify and rectify areas of concern before they create a long-term impact on loan performance and lender profitability.”
