The critical defect rate for U.S. mortgages climbed again in the third quarter of 2025, marking the third consecutive quarterly increase as lenders grappled with documentation challenges and leaner staff amid a shifting market.
According to data released Wednesday by ACES Quality Management, the overall critical defect rate stood at 1.79% during the third quarter, an 18.5% increase from the previous quarter’s 1.51% rate. While defect rates remained relatively low by historical standards, the steady quarterly increase suggests the industry is facing renewed operational friction as it transitions from a purchase-dominant environment to one with expanding refinance activity.
The report emphasized that the increasing defect rate was driven by rises in specific categories “rather than broad-based weakening.” Income and employment defects were the primary culprits, up 47.6% from the previous quarter to account for 27.24% of all critical defects in the third quarter.
“While the overall critical defect rate increased again in Q3 2025, the underlying data points to a market adjusting to a shifting mix rather than a broad decline in manufacturing quality,” said Nick Volpe, executive vice president of ACES Quality Management, in a press release accompanying the report.
Volpe attributed the spike in findings to the specific complexities introduced by refinance transactions and challenges with proper documentation.
“The increase was driven primarily by concentrated deterioration in income- and compliance-related findings, reinforcing the importance of documentation integrity and disciplined validation as refinance activity expands and lenders continue to operate lean,” he added.
As interest rates softened slightly in late 2025, refinance volumes began to tick upward. While refinance loans comprised only 19.05% of the files reviewed in the quarter, they accounted for a disproportionate 37.35% of all critical defects, up from 26.04% in the previous quarter, according to ACES’s data.
The report noted that refinance loans often introduce operational hurdles regarding “documentation refresh” requirements and validation timing, which can trip up underwriting teams. These challenges can be exacerbated by the “lean” staffing models many lenders have maintained following the market contraction of previous years.
Despite the rise in income and compliance errors, other areas showed improvement. Borrower and mortgage eligibility defects dropped significantly, falling from 15.87% to just 6.9% of all findings during the quarter.
The ACES report analyzed post-closing quality control data derived from the ACES Quality Management & Control benchmarking system. The findings are based on loan audits selected by lenders for full file reviews.
