Downsizing Continued to Impact Rate of Critical Defects in Mortgages in Q3

Published March 19, 2019

MortgageOrb by Patrick Barnard | March 18, 2019

The rate of critical defects in mortgage applications increased to 1.89% in the third quarter, up from 1.71% in the second quarter to reach the highest level since October 2015, according to ARMCO’s latest quarterly QC Trends Report.

That’s an increase of roughly 11% from the previous quarter.

Contributing to the increase was a 23% jump in critical defects attributed to loan package documentation. It was the fourth consecutive quarter to see a significant increase in this category.

Nearly 30% of all the loans with critical defects were Federal Housing Administration (FHA) loans. FHA loans accounted for nearly 50% of all loans sampled for the report.

Some categories of critical defects decreased relative to the previous quarter – for example, the number of defects attributed to the income/employment category dropped almost in half, from 22.73% in the second quarter to 12.50% in the third quarter.

The categories of credit and liabilities also increased moderately, and the percentage of property appraisal-related defects reached its highest point of the year.

“You can tell a lot about a market from the percentage and distribution of critical defects,” says Phil McCall, president and chief operating officer of ARMCO, in the report. “In the third quarter, defect activity indicates that lenders are still dealing with the quality issues that result from downsizing. We also see how lower volume markets can impact the quality of their loans.”

As McCall points out, “Downsizing can leave lenders with a less qualified workforce, which in turn leads to more errors, particularly with complex transactions and usually with loan documentation.”

McCall says the increases in defect rates related to credit and liabilities, as well as appraisals, “aligns with lower overall production and compressed margins, two key components of a hyper-competitive market.

“In an effort to win market share, investors often become more aggressive by expanding eligibility guidelines, while originators try to make up for declining volume by submitting loans of lower than usual quality,” he adds.

The report is based on nationwide post-closing quality control loan data from over 90,000 unique loans selected for random full-file reviews, as was captured by the company’s ACES Analytics benchmarking software.

Defects listed in the report are categorized using the Fannie Mae loan defect taxonomy.

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