A sharp rise in appraisal and borrower/mortgage eligibility defects eroded overall mortgage production quality in the second quarter, new figures from Aces Quality Management show.

The quality control firm’s quarterly Mortgage QC Industry Trends Report presents findings from tens of thousands of loan files, the company says, with “all reviews and defect data evaluated for the report based on audits selected by lenders for full file reviews.”

Purchase defect share fell to 73.96% of all defect findings in the second quarter from 80.43% in the first quarter, while refinance defect share increased to 26.04% from 19.57%.

Overall, Aces says, the quarterly findings show a mortgage industry “maintaining strong manufacturing quality amid shifting market conditions,” with the rise in critical defect rates “driven by changes in loan composition rather than a systemic decline in lender performance.”

The company observes that total loan originations increased 19.4% from the second quarter of 2024, attributing the gain to “seasonal momentum and short-lived rate dips” rather than any broad-based housing recovery.

Purchase activity fell year over year in the second quarter, the report notes, despite the usual boost associated with the spring homebuying season.

The report shows the overall critical defect rate increased more than 15% to 1.51% in the second quarter from 1.31% the previous quarter, a “modest increase” primarily driven by increased defects in collateral, eligibility and regulatory-related categories.

It is the second consecutive quarter of rising critical defect rates after that share fell to a historic low of 1.16% in the fourth quarter of 2024, Aces says. Current increases are “consistent with the shift toward more complex cash-out refinance activity,” given they involve “greater complexity in terms of collateral and income analysis.”

Refinance loans accounted for 17.33% of the reviewed files, up from 12.4% in the first quarter.

“Although the overall critical defect rate increased for a second straight quarter, the situation is nuanced,” says Nick Volpe, executive vice president at Aces Quality Management, in a statement accompanying the report, describing its findings as showing “mixed performance.”

Appraisal defects jumped 156.5%, rising from 2.3% to 5.9%, while borrower/mortgage eligibility defects more than doubled, rising to a 15.87% share of total critical defects from 6.9% the previous quarter.

Property eligibility defects rose to 4.06% of all findings in the second quarter after Aces reported none in the first quarter. Legal, regulatory and compliance defects rose to a 16.24% share from 14.94% in the first quarter, an 8.7% gain.

Meanwhile, income/employment defects — the highest defect share across all categories — improved to 18.45% of all findings from 22.99% in the first quarter, a nearly 20% reduction.

Asset defects rose quarterly to 12.92% from 11.49%, while credit and liabilities defects dropped by more than a third, shrinking to a 7.75% overall share each. Loan documentation and insurance defects declined “but remained volatile.”