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Critical defect rate highest since 2018

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Industry Spotlight
Monday, December 21, 2020
ACES Quality Management released its quarterly mortgage quality control report, covering the second quarter of 2020.

The report provides an analysis for post-closing quality control data taken from the company’s quality management and control software. The findings are based on data from over 90,000 unique loans and are categorized using the Fannie Mae loan defect taxonomy.

“While evidence of COVID-19’s impact on loan quality was present in Q1 data, Q2 is where ‘The COVID Effect’ becomes truly apparent, resulting in the highest critical defect rate observed since Q4 2018,” ACES Executive Vice President Nick Volpe said in a release. “One of the biggest drivers of this increase was the rise in income/employment-related defects – a wholly unsurprising outcome given the challenges nearly all employers faced in transitioning to a remote working environment.”

The critical defect rate was 1.88 percent, 20 percent higher than the prior quarter’s rate. According to the report, a critical defect is a defect that would result in the loan being uninsurable or ineligible for sale. The rate reflects the percentage of loans reviewed where at least one critical defect was identified during the post-closing quality control review.

While defects were down in the overall majority of categories, three of the four key borrower qualification categories saw significant defect rate increases compared to the first quarter of 2020, the release stated.

“In many respects, the mortgage industry and the world at large remain in a ‘wait-and-see’ mode,” Volpe added. “As such, we expect higher than normal volatility in the critical defect rate for the remaining quarters of 2020 and into 2021, though loan volumes should remain high next year thanks to the ongoing low-interest-rate environment.”

The report also showed the significant increase in the share of conventional and refinance loans, and early payment defaults (EPDs) increased 197 percent through Sept. 2020 compared to the same time last year.

“We are still seeing a tremendous increase overall in EPDs as compared to 2019, making it too early to predict when EPDs will peak,” ACES CEO Trevor Gauthier said. “Any continued rise is likely to exacerbate long-term default and loss rates, signaling that lenders must remain vigilant of the risks this might pose to their organizations.

“By increasing visibility into loan quality and introducing functionality specifically designed to accommodate the COVID-related changes to compliance regulations, ACES arms lenders with powerful quality control technology needed to manage that risk as they approach the great unknowns of the year ahead.”

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