Lenders saw fewer critical loan defects in the second quarter, but errors tied to income calculations, borrower eligibility, and appraisals became more prevalent, according to a new report from ACES Quality Management.
The overall critical defect rate fell to 1.64%, down from 1.71% in the first quarter. It was the first decline between the first and second quarters since 2023, although the rate remained 8.6% higher than a year earlier.
The improvement masked a shift in where lenders are encountering problems.
Income and employment findings accounted for 23.18% of all critical defects, up from 20.07% in the previous quarter, reclaiming the top spot among defect categories.
More than half of those findings, 51.43%, involved calculation or analysis errors, compared with 45.28% in the first quarter.
ACES attributed the growing pressure partly to the complexity of qualifying borrowers with variable, self-employed, or nontraditional income, where calculations often require additional manual work.
That puts greater emphasis on how qualifying income is calculated before a file reaches underwriting. Complete documentation alone may not prevent a defect if the income calculation is wrong.
Eligibility and Appraisal Findings Climb
Borrower and mortgage eligibility's share of critical defects jumped 60.4%, from 7.43% to 11.92%, making it the third-largest defect category.
Those findings can involve occupancy requirements, loan-to-value limits, and undisclosed subordinate financing, according to ACES.
Appraisal findings also increased, rising 38.5% to account for 4.64% of critical defects. While still a relatively small category, that was its highest share since the second quarter of 2025.
The findings come ahead of the industry's third-quarter quality-control results and follow the Nov. 2 mandatory transition to the new Uniform Appraisal Dataset, or UAD 3.6, for most applicable loans. The ACES data predates that mandate, but the increase adds another reason for lenders to monitor appraisal quality during the transition.
"Appraisal is often where problems arise first when property values are unsettled, and if the defect rate holds in the 4% to 5% range next quarter, we'll want to dig into what's driving it," said Nick Volpe, executive vice president of ACES Quality Management.
Refi Loans Remain a Trouble Spot
Refinance loans continued to account for a disproportionate share of critical defects, even as lenders reviewed fewer of them.
Refinances represented 20.83% of loans reviewed in the second quarter but accounted for 31.37% of critical defects. That gap widened to 10.54 percentage points, marking the 10th consecutive quarter in which refinance defect share exceeded its share of reviewed loans.
ACES suggested that borrowers rushing to close before rate locks expired may have contributed to the problem, leaving less time to resolve conditions and verify documentation.
Conventional loans also showed a deterioration relative to their share of reviews. They accounted for 65.01% of critical defects against 60.77% of reviewed loans, a larger disparity than FHA loans. VA loans, meanwhile, accounted for just 6.15% of defects despite representing 12.62% of reviews.
The report found one notable improvement: Legal, Regulatory and Compliance findings fell 17.3%, ending four consecutive quarterly increases.
ACES based its findings on tens of thousands of post-closing quality-control records from lender-selected full-file reviews. A critical defect is one that could make a loan uninsurable or ineligible for sale.
