Defects in mortgage loan files ended 2025 on the upswing, with the critical defect rate falling 41 basis points in the fourth quarter to 1.38%.

It marked a turnaround after three straight quarters of increases, according to a comprehensive report released Wednesday by ACES Quality Management, a provider of quality control software for the financial industry.

“Lenders ended 2025 on a strong note, with Q4 delivering a meaningful drop in the critical defect rate and the full-year average holding essentially flat versus 2024,” said Nick Volpe, executive vice president at ACES, in a press release accompanying the report.

Volpe added that a doubling of refinance review share in 2025 means lenders need to stay vigilant in that area.

“The year’s defining shift toward eligibility-driven defects as refinance activity returned indicates that disciplined documentation and consistent eligibility decisioning will define quality in 2026,” Volpe stated.

The refinance defect share more than doubled during 2025, the report noted, from 15.3% to 32.2%. The purchase defect share fell from 84.7% to 67.8% on a full-year basis.

On the eligibility side of the equation, borrower/eligibility defects spiked 291.6% year over year in 2025, while credit defects increased 166.1%. ACES said this reflects a “migration toward eligibility-driven defects as borrowers stretched to qualify in a constrained affordability environment.”

In terms of defect categories, legal/regulatory/compliance ranked first with a 24.7% share. Income/employment, which clocked a 21.5% share, fell from the top spot for only the second time since the fourth quarter of 2024.

By loan product type, conventional defect share decreased about 3% to 55.4%, while the defect share for loans backed by the Federal Housing Administration rose about 2.8% to just under 32%.

VA loans backed by the Department of Veterans Affairs saw their defect share increase for the second consecutive quarter to 12.3%, a trend the ACES report called “a particularly important one to monitor given the elevated headline risk associated with VA lending.”

But overall, ACES characterized the fourth-quarter results as being “consistent with the broader pattern observed throughout the year: a market normalizing rather than deteriorating, with quality outcomes oscillating in response to mix and macro conditions rather than reflecting systemic weakening.”