The Federal Housing Administration (FHA) has introduced its initial steps toward a new Single Family Loan Quality Assessment Methodology or what it is also calling a "defect taxonomy" for categorization of loan defects in loans it endorses.  These steps will ultimately result in a nine defect categories that will replace the 99 codes currently in use.   

FHA said it has been working for the past year on a series of changes aimed at improving its quality assurance process.  The new taxonomy centers on three core concepts: identifying a defect, capturing the sources and causes of a defect and assessing the severity of a defect and will complement the updated certification language already released by FHA and its new Handbook, the first section of which becomes effective in September.  These efforts are part of the agency's effort to provide greater clarity and transparency to single family lenders.  FHA says it expects this increased clarity will allow lenders to originate loans confidently-knowing their mortgages meet FHA standards.

The current 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. Much of the detail of the sources and causes of defects was only captured in loan reviewers' notes and thus could not be aggregated.

The new distinct defect categories will be 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 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.

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)

It is expected that under this new taxonomy the agency's approach to quality assurance will evolve into one with 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.

FHA said no effective date for the Defect Taxonomy has been set but by posting the information now lenders will have time to consider any changes or updates they may want to make to the own processes.  The agency also stressed that this is not a comprehensive statement on all of its compliance monitoring or enforcement efforts which are set forth in separate law

"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."

David H. Stevens, President and CEO of the Mortgage Bankers Association (MBA) and former commissioner of FHA said in a formal statement that the release of the FHA loan quality assurance framework standards is a step in the right direction towards helping FHA's parent Department of Housing and Urban Development (HUD) "focus on the most egregious risk in their portfolio and providing better clarity to lenders on which defects pose the greatest risk."