ACES Finds Second Consecutive Increase in Critical Defect Rate

ACES Quality Management, Denver, found the overall critical defect rate increased to 1.81% during the second quarter, moving closer to the precarious 2% threshold.

The second quarter represented the second consecutive quarter of growth in the critical defect rate after four quarters of decline.

“This quarter’s rise in critical defects signals that lenders need to double down on quality control efforts, especially as volumes grow,” ACES Quality Management Executive Vice President Nick Volpe said. “While the industry’s resilience is evident, the increased scrutiny of income and other key underwriting areas reminds us of the complexities in today’s lending landscape.”

Volpe recommended proactive adoption of digital tools as a key way to maintain high standards and navigate an environment “where even minor lapses can impact long-term performance.”

ACES reported Income/Employment remains the leading category of defects at 37.01%, followed by Assets at 14.29% and Credit at 9.79%.

Defects increased in all four major underwriting categories, with Income/Employment defects rising the most quarter-over-quarter.

Appraisal defects saw the most significant quarter-over-quarter growth across all categories, increasing by 98.33%.

Insurance defects reversed course from Q1 2024, declining 91.99%.

Lenders continued to prioritize purchase reviews over refinances, with defect share rising 2.71% for purchase transactions and declining 11.66% for refinances.

“Conventional and FHA review shares declined slightly this quarter,” the report said. “While VA review share increased somewhat, lenders significantly increased their reviews of USDA loans in Q2.”

FHA and VA loan performance improved tremendously over Q1, declining 35.26% and 56.57%, respectively. Conventional defect share increased by 13.59%, but the largest area of concern this quarter is USDA loan defects, which increased by 370.9%.