The mortgage industry’s critical defect rate rose sharply in the first quarter as compliance-related issues increased and lenders saw a resurgence in refinance activity, according to ACES Quality Management‘s quarterly Mortgage QC Industry Trends Report, released Tuesday.
The overall critical defect rate increased from 1.38% in the fourth quarter of 2025 to 1.71% in the first quarter of 2026. The rate was also up from 1.31% in the first quarter of 2025.
The report analyzes post-closing quality control data from ACES Quality Management & Control software and is based on loan audits selected by lenders for full-file reviews.
Legal, regulatory and compliance defects accounted for 26.02% of all defects in Q1 2026, up from 24.66% in the previous quarter. It marked the category’s fourth consecutive quarterly increase, its highest share since Q1 2021 and its second straight quarter as the leading defect category.
Income and employment defects fell from 21.52% to 20.07% but remained the second-largest defect category. It was the first time in five years that the category ranked No. 2 in back-to-back quarters, ACES said.
Asset defects posted the largest improvement among the major categories, falling from 15.25% to 10.41%. The decline ended three consecutive quarterly increases.
Credit defects also declined, falling from 5.38% to 5.2%, while liabilities defects were essentially unchanged at 10.78%, compared with 10.76% in Q4 2026.
The report also showed a continued shift toward refinance activity. The share of reviews involving refinances increased to 32.05%, up from 27.37%, marking the fourth consecutive quarterly increase and the highest level since Q1 2022. Refinance defects increased to 38.57% of all defects, up from 36.84% in Q4 2025.
“The 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,” Nick Volpe, executive vice president of ACES Quality Management, said in a statement.
Volpe said mortgage rates dipping below 6% in February drove a rapid increase in refinance activity, creating additional eligibility and compliance challenges for lenders.
“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,” Volpe said.
Department of Veterans Affairs (VA) loans posted the greatest product-level improvement, with their share of defects falling from 12.32% to 9.78%.
The Federal Housing Administration (FHA) loan defect share was largely unchanged at 32.27%, up from 31.96%. The share remained significantly higher than FHA’s 24.46% share of reviews, according to ACES.
The report’s findings are based on post-closing quality control data from ACES’ benchmarking system and include data from prior quarters where applicable. ACES said the report and previous editions are available to download for free on its website.
