June 18, 2015, the Federal Housing Administration released its Single-Family Loan Quality Assessment Methodology. Referred to as “Defect Taxonomy,” the system outlines a detailed process for quality assurance of Single-Family FHA endorsed loans.

Please click on the link below to review the 28-page document in its entirety:

Currently, FHA uses 99 different codes to describe defects in loans and the new quality assurance program is structured to give lenders additional information that helps identify challenges in originating FHA loans. The taxonomy will also allow FHA to monitor trends in deficiencies and allow lenders to enhance internal policies and comply with FHA standards.

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.Under the new guidance, quality assurance will consist of a limited number of defects 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. The four tiers are as follows:

Loan was submitted for endorsement with information which the lender knew(or should have known) was fraudulent or materially misrepresented; or loan was submitted for endorsement with information which the lender did not know (or could not have known) was fraudulent or materially misrepresented; or loan information provided in the loan file or in the input of loan file data in

TOTAL is significantly inconsistent and cannot be trusted, or is completely missing, which makes it impractical to determine whether the loan is compliant and approvable; loan contains an incurable violation of a statutory requirement.

Errors are present in loan file that, even if identified and corrected, would lead the loan to be unapprovable, either by: causing the loan to exceed approval limits by a large margin or causing the loan to fail to comply with loan guidelines by a large degree.

Errors are present in loan file that, even if identified and corrected, would lead the loan to be unapprovable, either by: causing the loan to exceed approval limits by a small margin or causing the loan to fail to comply with loan guidelines by a small degree.

Errors are present in loan file that impact key calculations or inputs, but which would not lead the loan to be unapprovable based on FHA limits and guidelines.

From the defect codes, FHA will be able to evaluate each loan and assign an overall loan rating. A loan receives one initial overall rating regardless of how many defects are noted. The defect code with the highest tier severity determines the overall loan rating. If new or additional information is discovered later, FHA reserves the right to re-evaluate the loan’s overall loan rating.

FHA’s 4-Tier severity rating system is structured in the reverse order of the quality assurance rating systems that have been used by FHA in the past as well as the severity rating systems adopted by Fannie Mae, Freddie Mac and other institutional investors.

The Enterprises will generally accept a lender’s quality assurance findings report with a tiered structure that may range from be 3 to 5 levels. However, a Level 1 is industry-standard for “minor errors and omissions” while a Level 2 might represent curable deficiencies that would make the loan acceptable. A Level 3 classifies a loan as not underwritten in accordance with investor guidelines and potentially ineligible. The 4 and 5 severity levels represent fraud, misrepresentation that would be reported to the investor.