What’s a Qualified Mortgage?

What's a Qualified Mortgage? article image.

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A Qualified Mortgage (QM) is a home loan that meets federal guidelines aimed at preventing lenders from issuing loans that borrowers can't afford to repay.

The U.S. Consumer Financial Protection Bureau (CFPB) created the Qualified Mortgage category in the wake of the 2008 financial crisis, which was precipitated by widespread defaults on mortgage loans. Many of these loans were issued on a "stated income" basis, without verification of the borrower's income or assets. Qualified Mortgages, and the CFPB itself, are outgrowths of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted by Congress in 2010.

Requirements for a Qualified Mortgage

As spelled out by the CFPB, QMs must meet four requirements:

  1. Ability-to-repay rule. The lender must make a good faith effort to ensure borrowers can make monthly mortgage payments by documenting income, assets, employment, credit history and monthly expenses. This rule excludes mortgages with low initial interest rates (known as teaser rates) that rise dramatically at the end of an introductory period.
  2. Restrictions on risky loans. Certain other types of mortgage loans that can put borrowers at risk are also excluded from QM status, including:
    • Loans that include reduced interest-only payments for a portion of the repayment period, during which the borrower accumulates no equity in the property.
    • Negative-amortization loans, under which the principal owed on the loan increases over the course of the repayment term.
    • Loans that call for a large final payment (often called a balloon payment) at the end of the repayment term.
    • Mortgages with repayment terms longer than 30 years.
  3. Income-based restrictions. Lenders issuing QMs must ascertain that monthly payments on the loan do not cause household debt-to-income (DTI) ratio to exceed 43%. DTI is calculated by dividing total monthly debt payments (including those on credit cards, auto loans, student loans and other forms of credit, as well as the mortgage loan) by the borrower's monthly pretax income. This measure aims to prevent borrowers from accepting mortgage loans that hurt their ability to cover their monthly debts.
  4. Limits on points and fees. A QM for $100,000 or more cannot require points (upfront payments characterized as percentage points of the total loan amount) or other fees that exceed 3% of the loan amount. Fees can be proportionally larger on smaller loans, as specified below:
Total Loan AmountMaximum Points & Fees
$100,000 or more 3% of the total loan amount
$60,000 to $99,999.99$3,000
$20,000 to $59,999.995% of the total loan amount
$12,500 to $19,999.99$1,000
Less than $12,5008% of the total loan amount

Source: Consumer Financial Protection Bureau

Federal Housing Administration (FHA) insurance premiums and certain other types of fees are not included in point and fee limits.

Types of Qualified Mortgages

When the CFPB set forth the Qualified Mortgage requirements listed above, it made provisions for certain special-case exemptions. As a result, there are currently three subcategories of loans that can be considered Qualified Mortgages:

  1. General-definition QMs: Mortgages that meet all four requirements listed above are known as general-definition QMs.
  2. GSE-eligible QMs: Conforming loans that meet requirements for purchase by Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that buy mortgages from lenders and convert them to securities traded by investors, are temporarily exempt from the QM 43% DTI requirement. This exemption will stay in place until January 10, 2021, or until the GSEs emerge from the conservatorship under the agency that regulates them, the Federal Housing Finance Administration (FHFA). After the 2008 housing crisis badly destabilized GSEs, the FHFA took control of them and is working to restore them to solid financial footing.

    Loans that qualify for insurance by the Federal Housing Administration (FHA), Veterans Administration (VA) or U.S. Department of Agriculture (which underwrites certain farm loans) also can be considered QMs regardless of the debt-to-income ratio, until those agencies issue their own QM rules or until January 10, 2021, whichever comes first.

  3. Small-creditor QMs. Mortgage lenders with less than $2 billion in assets that originate 500 or fewer private home mortgages annually—generally small banks and credit unions—can call their mortgages QMs if they keep the loans in their own portfolios (in other words, don't resell them to GSEs or other secondary buyers) and consider and verify each borrower's DTI as part of their lending decisions (though no specific DTI limit applies).

What Are the Benefits and Drawbacks of Qualified Mortgages?

The main reason the CFPB developed the Qualified Mortgage standard was to restore investor confidence in the U.S. mortgage market and in securities based on mortgage loans, after reckless and abusive lending practices helped spark the 2008 housing crisis. While they are designed to protect lenders (and their shareholders) from the kinds of mass defaults seen a decade ago, QMs also offer some assurances for consumers: The ability-to-pay and DTI requirements for QMs can help prevent borrowers from getting in over their heads with mortgage payments they can't afford.

On the downside, meeting the strict requirements of a Qualified Mortgage makes the mortgage approval process a little more labor-intensive for applicants, and the QM process may raise the bar a bit too high for some would-be homeowners. In the past, some of the riskier mortgage types barred under QM standards let marginal borrowers enter the housing market, with the goal of transitioning to a more traditional mortgage within a few years.

When to Consider a Non-Qualified Mortgage

Mortgages that don't meet QM standards are less common than QM loans, but many lenders still offer them. Note, however, that a lender's willingness to accept a DTI ratio greater than 43%, or to relax some other ability-to-pay requirements, doesn't mean they'll take any borrower with a pulse. In fact, they may look even harder at applicants' other resources than lenders offering QM loans.

So who are good candidates for non-QM mortgages? Wealthy borrowers with sizable real assets but relatively little income are one class of candidate. These borrowers might not meet the DTI ratio required for a Qualified Mortgage, but could easily prove the ability to liquidate investments as needed to make mortgage payments.

First-time homebuyers with moderate or low income who cannot meet Qualified Mortgage ability-to-pay requirements might also qualify for some non-QM mortgages, but they should be prepared to pay high interest rates and fees.

Do Credit Scores Affect Qualified Mortgages?

A major mortgage feature that isn't addressed by Qualified Mortgage requirements is the loan's interest rate. Just as they were in the days before QM rules, mortgage interest rates are set by lenders, based on your creditworthiness, as reflected in your credit history and measured by your credit score. A history of good debt management, including timely payments and moderate usage of your available credit limits, will tend to raise your credit score and help you qualify for a mortgage with the lowest interest rates, whether the loan is a Qualified Mortgage or not.

To know where you stand before you apply for a mortgage, it's a good idea to check your credit scores and review your credit reports from all three national credit bureaus (Experian, Equifax and TransUnion), which you can do through Experian or for free once a year at AnnualCreditReport.com. If your score isn't as strong you might hope, consider taking some steps to spruce up your credit before you apply for your mortgage.

Qualified Mortgage standards are helping shore up mortgage lenders and the government-sponsored companies that package them for Wall Street investors, and they're also making mortgages a little less risky for consumers. They make applying for and gaining approval on mortgages a bit more challenging, but they also make the mortgage market more stable and secure. Whether you end up seeking a QM or non-QM loan, establishing and maintaining a good credit history can help you get the best mortgage deal you can get.

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