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The Federal Housing Administration (FHA) has posted its Single Family Loan Quality Assessment Methodology or “Defect Taxonomy,” which explains how FHA intends to categorize loan defects found in Single Family FHA endorsed loans. The framework, part of the “Blueprint for Access,” centers on three core concepts: Identifying a defect, capturing the sources and causes of a defect and assessing the severity of a defect. The taxonomy is part of FHA’s effort to provide greater clarity and transparency to Single Family FHA approved lenders to encourage lending to qualified borrowers across the credit spectrum.
For the past year, FHA has been working on a series of changes aimed at enhancing its quality assurance process. The new taxonomy will complement the updated certification language FHA has released and FHA’s new Handbook, the first section of which becomes effective in September, creating a stronger quality assurance program. The increased clarity with respect to quality assurance measures enhances access for potential borrowers because lenders can originate loans confidently—knowing their mortgages meet FHA standards. By enhancing the way FHA provides policy direction and monitors lender compliance and performance, the FHA insurance fund, borrowers, lenders and taxpayers will be better protected.
“This new guidance gives lenders greater insight into how FHA will capture defects and their relative severities,” said Principal Deputy Assistant Secretary for Housing, Edward Golding. “By enhancing our approach, lenders will have more confidence in how they interact with FHA, and we anticipate will be more willing to lend to future homeowners who are ready to own.”
Currently, Single Family FHA uses 99 different codes to describe defects in loans. The taxonomy, once implemented, will bring this down to nine distinct defects, supported by codes that will identify the source and cause of the defect, and offer some new insight into the significance of a given deficiency within each category. This new approach will give lenders additional information that helps identify where their challenges are in originating FHA loans and allow them to make changes to reduce errors that potentially trigger enforcement actions. The taxonomy will also allow FHA to monitor trends in deficiencies and determine if policies can be enhanced to help lenders better comply with FHA standards.
“HUD’s decision today to release the FHA loan quality assurance framework standards is a step in the right direction towards helping HUD focus on the most egregious risk in their portfolio and providing better clarity to lenders on which defects pose the greatest risk," said David H. Stevens, President and CEO Mortgage Bankers Association (MBA). "There is more work that surely needs to be done and MBA believes that the industry’s input on issues such as this must be an important part of the decision making process to expand homeownership opportunity. MBA looks forward to continuing to work with FHA and all stakeholders on this and other issues that can help restore a vibrant real estate market.”
The nine defect categories under the new taxonomy are:
►Borrower Income (BI)
►Borrower credit/liabilities (BC)
►Loan to value and max mortgage amount (LM)
►Borrower Assets (BA)
►Property eligibility (PE)
►Property appraisal (PA)
►Borrower eligibility and qualification (BE)
►Mortgage eligibility (ME)
►Lender operations (LO)
Currently, FHA’s approach to quality assurance consists of defect codes that focus on distinct causes, with findings for each defect classified as being either Unacceptable or Deficient. Moreover, much of the detail of the sources and causes of defects was only captured in loan reviewers’ notes and thus, unable to be aggregated.
With the intended taxonomy, FHA’s approach to quality assurance will evolve. Under the new guidance, quality assurance will consist of a limited number of defects organized within each of the above-referenced nine categories. Defects will then be supported by more detailed categorization of the sources and causes of a defect and assigned to one of four tiers indicating the severity of the defect. Together these changes will create a more transparent and informative structure.
This Taxonomy is not a comprehensive statement on all compliance monitoring or enforcement efforts by FHA or the Federal Government and does not establish standards for administrative or civil enforcement action, which are set forth in separate law. Nor does it address FHA’s response to patterns and practice of loan-level defects, or FHA’s plans to address fraud or misrepresentation in connection with any FHA-insured loan.
An effective date for the Defect Taxonomy has not been set at this time. Posting the information now provides insight to lenders on the future approach that Single Family FHA will be adopting. This allows time for lenders to consider any changes or updates they may want to make to their internal quality control processes as a result.