The Federal Housing Administration (FHA) this week announced a proposed Mortgagee Letter (ML) that would add fraud and misrepresentation to its defect taxonomy list for Title II FHA-sponsored mortgage financing.

The defect taxonomy includes a list of attributes that FHA can use to identify potential defects at the loan level based on policy requirements from the U.S. Department of Housing and Urban Development (HUD). The newly proposed ML adds fraud or misrepresentation involving a third-party originator as a “tier 1 severity defect,” since lenders are responsible for the actions of their sponsored third-party originator (TPO) partners, FHA explained.

Tier 1 means that the lender “knew or should have known” about the defect. Currently, fraud or misrepresentation for TPOs under Title II loans can fall under either Tier 1 or Tier 4, the latter of which meaning that the lender “did not know and could not have known” about the defect.

“FHA is proposing these changes to better align the Defect Taxonomy with these existing requirements and mitigate risk to the Mutual Mortgage Insurance Fund (MMI Fund),” FHA specified. “The provisions of this Draft ML apply to all FHA Title II Single Family mortgage programs,” which primarily serve lower- and middle-income borrowers.

“Based on this update, FHA will seek life-of-loan indemnification from Mortgagees when there is evidence of fraud or material misrepresentation involving a sponsored TPO, regardless of whether FHA identifies specific red flags that should have been questioned at underwriting,” the draft ML reads.

The draft ML is available to view through the FHA’s Single Family Drafting Table, an online portal that allows stakeholders to view proposed policies prior to implementation. Feedback can be provided to FHA through June 24 using a dedicated response worksheet that is also available online.