FHA Announces Updated Defect Taxonomy to Clarify its Plan for Classifying Loan Defects Found in its Single-Family Loan Portfolio

Mortgage Origination FHA

On June 18, the FHA released its Single-Family Housing Loan Quality Assessment Methodology (“Defect Taxonomy”), a framework outlining the agency’s plans to identify and capture information related to loan defects found in Single-Family FHA endorsed loans. The new framework is intended to increase the efficacy of FHA’s Quality Assurance efforts and focuses on three core concepts – (i) identifying defects, (ii) capturing the sources and causes of defects, and (iii) assessing the severity of defects. Once implemented, the Defect Taxonomy will reduce the number of codes that the FHA uses to describe loan defects from 99 to nine.  Additionally, the Defect Taxonomy will implement “Basis of Ratings Codes” that will capture both the sources and causes of defects.  Finally, the Defect Taxonomy will refine FHA’s process for communicating the severity of defects by subdividing its current categories of “Unacceptable” and “Deficient” findings into four tiers of findings that will describe defects in greater detail. The FHA anticipates that these changes will provide greater transparency to lenders so that they can mitigate their credit risk when originating FHA loans. FHA further hopes that the Defect Taxonomy will help FHA monitor for deficiency trends and enhance its program policies.  In its announcement, FHA warns that the Defect 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….”  FHA also maintains that the Defect Taxonomy does not address how FHA will respond (i) to findings of patterns and practices of loan-level defects in FHA originations or (ii) to findings of fraud or misrepresentation in connection with any FHA-insured loan.  FHA has yet to set a date for the Defect Taxonomy to take effect.