FHA's New Loan Defect Taxonomy Is No Panacea for Enforcement Woes

The Federal Housing Administration's new loan defect "taxonomy" may give lenders better clarity on the quality assurance reviews of FHA loans, but it's not a shield from possible enforcement action by the Department of Justice and other regulators.

The taxonomy is designed to help lenders identify underwriting issues and reduce errors that could lead to enforcement actions, according to Department of Housing and Urban Development principal deputy secretary Edward Golding.

"This new guidance gives lenders greater insight into how FHA will capture defects and their relative severities," Golding said in a press release."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."

The FHA currently uses 99 different codes to describe underwriting faults. Going forward, it will employ just nine defect categories, such as borrower income, loan-to-value/maximum mortgage amount and borrower assets.

However, the new compliance guidance comes with a disclaimer regarding possible enforcement actions by the FHA or Department of Justice.

"This taxonomy is not a universal 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 a separate law," according to an FHA paper issued June 18 that outlines the loan defect taxonomy.

Lenders were hoping the new guidance would provide some relief from DOJ enforcement actions. However, the disclaimer indicates lenders will continue to be "second-guessed" by regulators, according to mortgage consultant Brian Chappelle.

"For lenders who have been through the Department of Justice process, that has to be a serious concern," he said in an interview. Chappelle is a co-founder of Potomac Partners in Washington, D.C. and a former FHA executive.

Quicken Loans CEO Bill Emerson added the announcement "does nothing to reduce the confusion or increase the confidence that lenders can originate and insure loans through FHA without severe and unknown risk."

The loan defect taxonomy disclaimer "renders the entire attempt by FHA to clarify its rules ineffectual, while continuing to provide the Justice Department free reign to interfere in the FHA program," Emerson said in an emailed response for comment.

Emerson, who also currently serves as chairman-elect of the Mortgage Bankers Association, claims the DOJ has "hijacked" the FHA program in efforts to punish lenders that don't make perfect loans.

In a preemptive move, Quicken Loans sued DOJ on April 20, just a few days before government lawyers filed their own lawsuit against Quicken Loans. The DOJ suit alleges the Detroit-based lender engaged in shoddy underwriting of hundreds of FHA-insured loans between September 2007 and December 2011.

Several large lenders have reduced their FHA lending activities over the past few years following allegations of originating noncompliant loans. In February 2014, JPMorgan Chase entered into a $614 million settlement with the Justice Department and HUD Inspector General for its underwriting practices involving FHA-insured loans.

The taxonomy needs industry input to provide more clarity around the loan decision making process, said MBA CEO David Stevens.

"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," he said in a statement.