Lenders need to be aware of a possible investor backlash as critical defects found in closed loans increased in frequency as the shift continued to a purchase market.
These defects, the errors that make a mortgage loan uninsurable or ineligible for sale in the secondary market, were seen in 1.76% of all mortgages originated in the second quarter, up from 1.61% in the first quarter and 1.63% in the second quarter of 2016, according to Aces Risk Management. This makes three consecutive quarters of an increased percentage in critical defects.
The most common finding in the post-closing quality control process was errors involving borrower and mortgage eligibility, seen in 26% of all closed loans with a critical error. Credit was next at 24% and income/employment problems were found in 16%.
The Fannie Mae loan defect taxonomy was used to define the types of errors found.
"We're seeing a continuation of critical defect activity that aligns with what we'd expect in a purchase-driven market," Aces Risk Management President Phil McCall said in a press release. "If they haven't already done so, lenders should consider how they'll address these specific loan quality issues if purchases continue to dominate the market."
"Investors are tracking these trends as well, and could make adjustments to protect themselves from what they see as potentially damaging market trends — lenders need to be aware of that," he continued.
There was a marked decline in the percentage of closed loans that had a critical defect related to legal or compliance issues, to 7.3% of closed loans from a peak of 22.9% in the third quarter of 2016.
During the early part of 2016, investors and lenders clashed on the eligibility of loans that contained defects because of mistakes on the TILA-RESPA Integrated Disclosure, the report said.
But lenders and investors made changes to their processes that reduced the number of defects associated with TRID. This was combined with a reclassification of many defects considered as high or critical into the moderate or lower categories.
Nearly 75% of the second-quarter closed loans reviewed were for home purchases. These loans accounted for 80% of the critical defects found.