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QUESTION:

What does Fannie Mae require when establishing a target defect rate in relation to a mortgage lender’s quality control (QC) program?

ANSWER:

In order to evaluate and measure loan quality standards effectively, Fannie Mae requires mortgage lenders establish a target defect rate related to its post-closing random QC sample, reflecting the lender’s quality standards and goals. Fannie Mae advises that different target defect rates may be established for different severity levels. However, at a minimum, a target defect rate must be established for the lender’s highest level of severity. A lender must document the rationale for establishing its target defect rate(s). In the August 2023 issue of Beyond the Guide (Guide), Fannie Mae provided helpful tips to establish an appropriate target defect rate. The Guide advised that realistic targets should be:

• Set as low as possible;
• Designed to be reduced over time;
• Based on financial analysis of costs associated with defective loans;
• Evaluated at least annually against updated performance, default and capital needs; and
• Used to quantify the risk exposure of defects and drive change.

Fannie Mae requires lenders to document the rationale used to establish the target defect rate(s). Fannie Mae also requires lenders to measure performance against their target defect rate(s) at least quarterly and report results to management. The gross defect rate is the true measure of a lender’s manufacturing quality for its overall book of business. Lenders must evaluate the target defect rate(s) at least annually and reset, if necessary, with the goal of reducing defects over time.