ARMCO: Critical Defect Rate Improves; FHA Loan Quality Decreases

ACES Risk Management, Denver, released its quarterly Mortgage QC Trends Report, showing a continued drop in overall critical defects but an uptick in FHA loan performance.

The report said in the second quarter, the overall critical defect rate declined for two consecutive quarters for the first time since Q3 2016, falling by 5.5% to 1.72%, with a 9.0% decline from the 2018 peak rate of 1.93% (Q4 2018).

ARMCO noted the decline in critical defects coincides with two consecutive quarters of strong but steady loan volume and a three-year high in lender profitability, according to the most recent Quarterly Performance Report issued by the Mortgage Bankers Association.

Other key report findings:

–Defects in Income/Employment and Credit, both core underwriting functions, declined 32.0% and 22.0%, respectively, in the second quarter from the first quarter.

–Interest rates in the second quarter were nearly a full point lower than Q2 2018 (3.3% vs 4.2%), which fueled a high refi-to-purchase ratio.

–Refinances comprised a higher percentage of all loans reviewed in the second quarter when compared to previous quarters, and were a driver in the quarter’s lower critical defect rates.

–Critical defects on FHA loans underperformed conventional loans by a greater percentage than previous quarters.

ARMCO Chief Strategy Officer Nick Volpe said volume fluctuations like those seen in prior quarters cause challenges for lenders, which often respond to sudden spikes and dips by adjusting their labor forces through layoffs, downsizing, re-allocating staff and hiring. “These changes upset the status quo and usually result in more defects, because staff instability increases errors and oversights,” Volpe said. “When lenders adapt, usually when the market steadies, defects decrease. It is therefore safe to say that when lenders use technology that improves their scalability, they increase profitability faster than those who rely on manual processes.”