Downsizing leads to increase in critical mortgage defects: ARMCO

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Industry downsizing resulted in an increase in critical defects found in closed mortgages as loan packaging errors continued to rise during the first quarter, according to a report from Aces Risk Management.

This should be an area of concern for mortgage lenders and the secondary market given the recent announcements of job eliminations, especially in back office positions.

The shift in the distribution of critical defect causes reflected the growing percentage of purchase loans and the overall decline in mortgage originations, as well as the job reductions.

While defects associated with loan packaging documentation errors do not typically result in a mortgage that can't be sold in the secondary market, it can impact a lender's profitability, Phil McCall, the president of ARMCO, said in a press release.

"These types of errors often occur when staff members are rushed or unfamiliar with job tasks. Omitting a document required by an investor or insurer is a typical example," he said.

"Errors like this can cause investors and insurers to suspend loan purchases, which reduces warehouse line capacity and can result in pricing adjustments, both of which significantly impair profitability."

The critical defect rate for the first quarter was 1.72%, up from 1.68% in the fourth quarter of 2017 and 1.61% in last year's first quarter.

"The distribution of critical defects for the first quarter of this year differed significantly from those we saw during the last quarter of 2017," said McCall. "What the report reveals is consistent purchase-dominant contracting markets."

The largest share of closed loan defects was found in the income and employment category, at 24.82% (up from 19.9% in the fourth quarter and 20.79% one year prior), followed by assets at 20.44% (up from 13.27% in the fourth quarter and 9.9% one year prior). ARMCO uses the Fannie Mae taxonomy to categorize defects.

Loan package documentation errors made up 16.06% of the critical defects found, an increase from the 12.76% found in the fourth quarter. But going back even further, packaging errors were just 9.58% in the third quarter, 4.17% in the second quarter and 4.95% in the first quarter last year.

On the other hand, borrower and mortgage eligibility defects were at 6.57%, compared with 23.76% for the first quarter of 2017.

Critical defects are a red flag for the possibility of mortgage fraud, although not a finding that there was any unscrupulous behavior.

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