Quality Control Can Address Rising Defect Rates, Improve Lenders’ Results
As the U.S. takes its first tentative steps toward post-pandemic recovery, the mortgage industry can play its part by helping Americans capitalize on low interest rates through home purchases and refinancing while ensuring secondary market stability through the production of investment-quality mortgages. Lenders must navigate the delicate balance of meeting demand without sacrificing mortgage processing quality. This is where a robust quality control (QC) process plays a critical role.
Loan quality defect rates increased among some lenders during 2020, underscoring the need for a more reliable QC process amid increasing mortgage volumes, changing agency requirements and remote work. The goal: To avoid costly repurchases and defaults as well as lessen the threat to communities from foreclosure.
A closer look at defect rates and their drivers might help pinpoint where to step up your QC efforts.
Defects: Where They Occurred Most and Possible Causes
Early signs of increasing critical defect rates began in 2019 with a consistent upward trend. As defect rate trends continued to climb into the first quarter of 2020, particularly among smaller lenders, we looked at the possible causes. Three leading trends include:
- Violations of the COVID-19 temporary flexibilities, which were related to a significant spike in defects in 2020.
- Loan manufacturing defects such as missing documentation to support liabilities, prior bankruptcies and income.
- Miscalculation of income and income documents missing, which were the top reasons for repurchase.
Other possible causes in the rise in defects may be because of:
- Covid-19 resulting in fluctuating incomes or temporary unemployment, making it difficult to evaluate income stability.
- Lenders’ ability to effectively operationalize and train on COVID-19 related changes to policy.
- The impact of hiring and training new staff amid rising residential mortgage lending volumes while at the same time adapting to a new work from home environment.
Self-Employment and QC Pitfalls Amid COVID-19
While some reasons behind the increase in defects could diminish quickly, other borrower circumstances such as those relating to self-employed borrowers could linger. According to U.S. Census Bureau Household and Small Business Pulse surveys, self-employed workers in states where businesses were hardest hit by Covid-19 face more economic hardships.
Many loan quality issues we found centered around the stable monthly income and documentation requirements for self-employed borrowers, specifically:
- Satisfactory verification that the business was open and operating within 20 business days of closing.
- Missing profit and loss statements.
Time to Double Down on QC Best Practices
With optimism of a robust post-pandemic economic recovery and a shortage of housing inventory, lenders will likely see applications for home financing remain high, so a renewed focus on QC is critical. A good place to begin is to address challenges at the onset. For example, lenders leveraging technology that automates the assessment of borrower assets and income are seeing a three- to five-day reduction in loan origination cycle times while at the same time reducing process risk. These tools also make it easier and safer—by limiting the possibility of human error—to underwrite self-employed borrowers leading to a reduction in the amount of income related defects.
While there’s no universal QC program, tightening up basic best practices can help. These include:
- Monitor carefully and conduct regular performance evaluations of any third parties involved in your QC program.
- Revisit QC practices regularly, especially when there have been changes to your processes, products, eligibility, or underwriting requirements.
- Use checklists to promote consistency and efficiency in your reviews.
- Incorporate controls or reviews that promote fair lending principles and ensure compliance with anti-predatory lending requirements.
- Use a combination of pre- and post-closing QC reviews with targeted and random sampling.
- Strengthen your re-verification process and make sure it’s the centerpiece of your QC program.
- Always protect a borrower’s personal information against accidental disclosure to unauthorized recipients, especially during re-verification.
- Revisit and strengthen your documentation and reporting procedures for timeliness, proper distribution to management, corrective action, and tracking and trending.
- Gather feedback on your program regularly and use it to identify areas for improvement, prevent and detect fraud, and improve training programs.
Ensuring your QC processes are robust will pay off both for you and an economy in need of a constructive recovery.