Mortgage application defects shrank in 3Q 2021

Critical defects on mortgage applications submitted in the third quarter last year were at the lowest level since the pandemic started, but with the economic turmoil affecting consumers, lenders should not be complacent, Aces Quality Management said.

An 8% decline in origination volume in the period helped the defect rate fall to 1.86%, a drop of 18% compared with the second quarter’s 2.27%. The critical defect rate for the third quarter of 2020 was 2.34%.

“Metrics are beginning to trend back to their historic normal levels as volume moderates,” Aces Executive Vice President Nick Volpe said in a press release. “With the amount of volatility in macroeconomic factors and rising rates, the decline in the overall critical defect rate is a testament to lenders taking quality management and control seriously.”

However, an increase in the share of critical defects related to income and employment was recorded, to 33.33% from 32.08% the prior quarter.

“The numbers continue a multi-quarter trend of increasing share of income/employment defects, and that category remains at an all-time high,” Aces said in its commentary. “It also illustrates, we believe, the difficulties that lenders face at the end of a refinance cycle where loans and borrower profiles tend to be more complex and difficult to qualify.”

Even though employment trends have improved since the start of the pandemic, lenders should enact targeted pre-funding quality control measures on income calculation and documentation, Aces suggested.

Other key categories of defects that increased from the prior quarter were assets, up to 16.58% from 10%; and borrower and mortgage eligibility, at 12.3% from 10.83%. Aces uses the Fannie Mae defect taxonomy.

Conversely, the use of appraisal waivers led defects in that category to fall to 2.12% from 5.42% on a quarter-to-quarter basis. But as originations become more purchase-heavy — along with more cash-out refinancings — from rate and term refi-dominant, lenders need to keep an eye for potential fraud issues.

Also, economic conditions have changed vastly in the period since this report was compiled — mortgage rate stopped 5% in the most recent Freddie Mac survey, and the conflict between Ukraine and Russia is driving inflationary pressures — making misstatements in mortgage applications more likely to occur as borrowers try to make purchases in a highly competitive market.

“Lenders and banks need to be cognizant of the economic and geopolitical environments in the coming months and possibly years,” Aces CEO Trevor Gauthier said. “As the Federal Reserve works to calm inflation, these actions oftentimes have a ripple effect, which can certainly impact loan quality.”