On June 18, 2015, the Federal Housing Administration (FHA) posted the methodology (Single Family Loan Quality Assessment Methodology or “Defect Taxonomy”) it intends to use to categorize loan defects found in single-family FHA endorsed loans. The Defect Taxonomy will inform when a lender must indemnify the FHA. “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.” Press Release, FHA Proposes Clearer Rules For Lenders With Updated Defect Taxonomy, FHA.gov (June 18, 2015).
The FHA prepared the methodology as part its “effort to provide greater clarity and transparency to Single Family FHA approved lenders to encourage lending to qualified borrowers across the credit spectrum.” Id.The Defect Taxonomy looks to “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.” Id.
Once implemented, the Defect Taxonomy will use only nine codes to describe defects in Single Family FHA loans, down from the 99 codes used currently. According to FHA, the new coding system “will identify the source and cause of the defect, and offer some new insight into the significance of a given deficiency within each category.” Id. The Defect Taxonomy’s approach aims to provide lenders with additional information that will allow them to capture their errors in originating FHA loans so that they can correct the issue, and to help lenders better comply with FHA standards.
The nine defect categories under the new taxonomy are: borrower income; borrower credit and liabilities; loan to value and max mortgage amount; borrower assets; property eligibility; property appraisal; borrower eligibility and qualification; mortgage eligibility; and lender operations.
The current system involves defect codes that focus on distinct causes, the details of which cannot be aggregated. The Defect Taxonomy seeks to permit aggregation by organizing the system such that only a limited number of defects will be organized within each of the 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.” Id. The changes aim to create a “more transparent and informative structure.” Id.
These things being said, 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, which are set forth in separate law.” Id. Nor for that matter does the Defect Taxonomy 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.” Id.
In other words, though the Defect Taxonomy may aid single-family FHA lenders in their efforts to avoid liability, it does not provide guidance on what happens if those lenders write bad loans. As a result, it is unlikely the Defect Taxonomy will help boost lending.
FHA has not set an effective date for the Defect Taxonomy.