DENVER — The critical defect rate for mortgages increased nearly 24% during the first quarter as lenders dealt with increased refinancing activity and continued compliance challenges, according to a new report from ACES Quality Management.
The company’s Q1 2026 ACES Mortgage QC Industry Trends Report found the overall critical defect rate rose to 1.71%, up 23.9% from 1.38% in the fourth quarter of 2025.
The rate was also 30.5% higher than the 1.31% recorded during the first quarter of 2025, ACES said.
“Q1’s swing back above 1.7% is a reminder that mortgage quality doesn’t move in a straight line, especially in a rate environment as volatile as this one,” said Nick Volpe, executive vice president of ACES Quality Management.
Rapid Increase in Refi’s
Volpe said a decline in mortgage rates below 6% in February triggered a rapid increase in refinancing activity that created additional eligibility and compliance challenges for lenders.
“The dip below 6% in February pulled a wave of refinance activity through lenders’ pipelines almost overnight, and this quarter’s data shows the eligibility and compliance friction that came with it,” Volpe said.
Compliance Defects Continue to Rise
Legal, regulatory and compliance issues remained the largest source of mortgage defects during the quarter, according to the Denver-based provider of quality management and control software for financial services companies.
Among ACES’ findings:
- Legal/Regulatory/Compliance: Defects increased 5.5%, rising from 24.66% of defects in the fourth quarter to 26.02% in the first quarter. It marked the category’s fourth consecutive quarterly increase, its highest share since the first quarter of 2021 and the second consecutive quarter in which it was the leading defect category.
- Income/Employment: Defects declined 6.7%, from 21.52% to 20.07%, but remained the second-largest category for the second consecutive quarter. ACES said it was the first time in five years the category had ranked second in back-to-back quarters.
- Assets: Defects dropped 31.7%, from 15.25% to 10.41%. ACES said it was the largest improvement among individual defect categories during the quarter and ended three consecutive quarterly increases.
- Credit: Defects declined 3.4%, from 5.38% to 5.2%.
- Liabilities: Defects were essentially unchanged, edging up from 10.76% to 10.78%.
Refi‘s Increase
The report also showed refinancing accounted for a growing share of the mortgages lenders selected for quality-control reviews.
Refinances represented 32.05% of reviewed loans during the first quarter, up from 27.37% in the fourth quarter. That marked the fourth consecutive quarterly increase and the highest refinance review share since the first quarter of 2022.
Refinances also accounted for a disproportionately large share of defects. Their defect share increased from 36.84% in the fourth quarter to 38.57% in the first quarter.
Volpe said lenders’ ability to adjust quality-control operations rapidly could become increasingly important if mortgage rates continue to fluctuate.
“For lenders, success in 2026 will likely depend on their ability to flex their QC capacity as quickly as the rate environment is shifting in the current market,” he said.
VA Loans Show Improvement
ACES also reported significant differences among mortgage products.
The share of defects associated with Department of Veterans Affairs loans declined 20.6%, falling from 12.32% to 9.78%. ACES called that the strongest product-level result during the quarter.
Federal Housing Administration loans showed little improvement. FHA loans accounted for 32.27% of defects, compared with 31.96% during the previous quarter.
That remained well above FHA loans’ 24.46% share of loans reviewed, ACES said.
The report is based on post-closing quality-control data collected through the company’s ACES Quality Management & Control benchmarking system. The analysis includes loan audits selected by lenders for full-file reviews and incorporates data from earlier quarters when applicable.
ACES said its software is used by more than 70% of the nation’s top 20 independent mortgage lenders, seven of the top 10 loan servicers, 14 of the top 30 banks and seven of the top 15 U.S. credit unions.
