FHA seeks to increase lender liability for third-party fraud

The Federal Housing Administration is looking to update the defect taxonomy it uses to assess loan quality with a stricter stance on material misrepresentations and fraud by third-party originators.

Currently, loans that the FHA insures which have these issues can either be categorized as Tier 4 severity issues that lenders "did not know and could not have known" about, or Tier 1 concerns that funders "knew or should have known about." 

The FHA has been determining whether an issue fits into the latter category based on whether one of its employees was involved or whether there were red flags in the loan file that should have been caught in underwriting.

Under the drafted change, sponsored TPOs connected with evidence of fraud or material misrepresentation also will be included in the Tier 1 category regardless of whether or not there were specific red flags. FHA will seek life-of-loan indemnification from lenders in this instance.

The FHA will accept feedback on the draft policy with implications for lenders who buy closed loans from correspondents or source them via brokers through June 24. It plans to publish a final mortgagee letter thereafter.

Mortgage and housing groups contacted by this publication didn't immediately voice a concern about the potential update to the defect taxonomy and were generally still reviewing it at press time.

"The CHLA is supportive of what this provision would do, which is hold lenders responsible for fraud and misrepresentation with respect to third-party originators," said Scott Olson, executive director of the Community Home Lenders of America, sharing his initial impressions of it.

Although there was some initial skepticism of the defect taxonomy's limits when it was introduced in 2015, the industry has generally found it helpful to have a framework for how the FHA views loan defects that can occur at origination and lead to performance issues later.

In addition to establishing an origination defect taxonomy, the Department of Housing and Development agency has proposed setting up a similar framework for servicing.