Mortgage loan critical defects reached high point in 2021

Last year was the worst ever for critical defects on mortgage applications, as pandemic-related stress on lender operations in the first half resulted in high rates of material misstatements slipping through, according to Aces Quality Management.

Meanwhile, the fourth quarter critical defect rate increased 4% over the prior three months due to the continuing shift to a purchase market that is more susceptible to possible fraud.

Slowing mortgage origination activity helped keep a larger increase at bay, as lenders were able to stabilize the workflow in their back offices, Aces continued. 

For the full year, the critical defect rate was 2.01%, up from 1.97% in 2020 and 1.71% for 2019, before the pandemic started. Aces started tracking this in 2016.

Critical defect findings increased in the fourth quarter to 1.95%, compared with 1.87% for the third quarter and 2.09% during the fourth quarter of 2021.

"Given the uptick in the fourth quarter and the persistent issues we're still seeing in the income/employment category, lenders should focus their efforts on shoring up this component of their underwriting process," Aces executive vice president Nick Volpe said in a press release.

Mortgage fraud is more likely on a purchase application because the motivation is to get the buyer into a home.

Aces uses the Fannie Mae mortgage defect taxonomy for its categorizations.

The fourth quarter actually featured a lower income/employment defect rate than the third quarter, 26.63% versus 33.16%, but it was still the leading category by far.

Assets remained the second most common defect, at 16.08%, 50 basis points lower than the third quarter.

But loan documentation defects soared during the fourth quarter, to 14.57% from 7.49% in the prior three months. And over the same time frame, appraisal defects increased to 7.04% from 2.67%.

However, expiration of COVID-specific mortgage lending regulations at the state level was likely the driver for the drop to a 3.52% critical defect rate from 9.63% on a quarter-to-quarter basis.

While lower volume gave lenders the opportunity to concentrate on the files that already came in the door, the slowdown in business is likely to increase critical defects in the future. They are starting to widen their credit box in order to keep volume up, Volpe said.

"As lenders battle over volume, quality control and compliance teams are more important than ever to ensure that the loans that make it through the door meet all regulatory and eligibility requirements," added Aces CEO Trevor Gauthier. "On the origination side, we're seeing the credit box expand to help qualify more borrowers and maintain share."

At the same time, federal and state regulators are increasing their scrutiny on mortgage servicers, so the industry must remain diligent in their compliance practices, Gauthier warned.