Mortgage production defect rates declined in 4Q

Improvements in mortgage loan production processes resulted in fewer manufacturing errors in the fourth quarter of 2022 versus the previous three-month period, according to Aces Quality Management.

But because of the high number of findings in the second and third quarter, the full-year rate increased by 6 basis points to 2.07% compared with 2021 when it was 2.01%.

The fourth quarter's critical defect rate of 1.84% came after two consecutive quarters where the rate was over 2%, including peaking at 2.47% for the period ended Sept. 30, 2022. The drop was attributed to lenders adjusting during the fourth quarter to the huge decline in production because of rising interest rates.

For the fourth quarter of 2021, the rate was 1.95%.

Aces Quality Management uses the Fannie Mae loan defect taxonomy to classify its findings from post-closing reviews of loan files selected for audit by lenders.

This drop in the critical defect rate from the third quarter's historical high was encouraging, even as declining mortgage origination volumes affected company underwriting operations, said Nick Volpe, Aces executive vice president.

"However, lenders are starting to see the government-sponsored enterprises take an aggressive stance on repurchase requests for loans with curable defects," Volpe said in a press release. "In addition, the Department of Housing and Urban Development has yet to complete its reviews of some vintage Federal Housing Administration loan production, an area notorious for defects." That could be problematic for already financially strapped mortgage lenders, Volpe continued.

Certain categories of defects, particularly income and employment related, increased between the third and fourth quarter.

This group of errors was found in 36.9% of the files reviewed, up from 24.7% in the third quarter.

"Understandably, lenders are trying to qualify and approve every application they take, but they must do so cautiously," the Aces report said. "Higher interest rates and property taxes are pressuring debt-to-income ratios, so accurately calculating the income portion of the lending equation will be paramount to avoiding defects in this area moving forward."

Asset was the next largest category, at 18.1% in the fourth quarter, versus 15.1% three months prior.

Among the other two categories Aces considers as part of its "big 4" to keep an eye on, credit was down to 4% in the fourth quarter from 11.9% in the third quarter, while liabilities were relatively flat at 6.7% compared with 6.9% the period before.

Loan documentation defects fell to 9.4% from 13.7%; and legal/regulatory/compliance to 5.4% from 11%.

On the other hand, borrower and mortgage eligibility problems increased to 14.1% from 9.1%, while appraisal was up to 4.7% from 2.7%.

In the fourth quarter, while 66% of all production reviewed was conventional mortgages, they had 50.4% of the defects found.

On the other hand, FHA loans made up 20.5% of originations but 38.8% of files with errors. Veterans Affairs-guaranteed mortgages were 10.9% of files examined, but had 7.8% of defects.