The hit 2015 film The Big Short, based on the best selling book by Michael Lewis, dramatically illustrated how the 2008 financial crisis had its origins in mortgages that the borrowers could never afford. As a result of this financial crisis and the Great Recession, many reforms were created to help prevent lenders from making risky loans that would leave borrowers underwater or in foreclosure. In 2014, the Consumer Financial Protection Bureau created a category of home loans called a Qualified Mortgage that includes features to help protect homeowners from mortgages that they couldn't afford. In 2016, 91% of all mortgages met the standards of Qualified Mortgage, up from 86% in 2015.
What Makes a Loan a Qualified Mortgage?
Qualified Mortgages make up an entire category of loans designed to allow homeowners to afford them. The Consumer Financial Protection Bureau (CFPB) has issued regulations that specify what can and can't be included in a loan labelled a Qualified Mortgage.
Here are the four kinds of rules that Qualified Mortgages have to comply with:
- The Ability-to-repay rule
To issue a Qualified Mortgage, a lender must make a good faith effort to ensure that you can make your payments, which is called the "ability-to-repay" rule. To do this, lenders must document your income, assets, employment, credit history and your monthly expenses. This rule excludes stated income loans, which were popular before the 2008 financial crisis because borrowers didn't need to verify their income. This rule also prevents lenders from issuing a Qualified Mortgage that has a low introductory rate that rises dramatically at a later time, often called a "teaser."
- Restrictions on risky loans
Other types of high-risk loans, sometimes called toxic loans, are forbidden, including those with an interest-only period that doesn't pay down your principal. Likewise, a Qualified Mortgage cannot be a loan with negative amortization that allows your principal to increase over time as you make payments. Loans with large payments at the end of the term, often called balloon payments, are also forbidden in a Qualified Mortgage. And a Qualified Mortgage can't include repayment terms longer than 30 years.
- Income-based restrictions
Qualified Mortgages are also limited in their loan amount, based on your income. These mortgages prevent borrowers from having their total monthly debt payments exceed 43% of their pre-tax income. The ratio of your monthly payments to your pre-tax income is often referred to as your debt-to-income ratio, and it includes other loans such as car loans, student loans and credit card payments.
- Limits on points and fees
To offer a Qualified Mortgage, lenders can't charge excessive points and fees. The maximum amount varies depending on the size of the loan, but for mortgages above $100,000, the total amount of fees can't exceed 3% of the loan. For loans of less than $100,000, the points and fees can exceed 3%. However, Federal Housing Administration (FHA) insurance premiums and certain other types of fees are not included in this limit.
Why Lends Like Qualified Mortgages
There are several benefits to a lender when it issues a Qualified Mortgage. For example, the Federal Housing Finance Agency (FHFA) has directed Fannie Mae and Freddie Mac not to purchase a loan unless it meets requirements for a Qualified Mortgage. Also, lenders are protected against lawsuits from borrowers who are unable to repay their loans.
This is often called the safe-harbor protection. Also, lenders are able to resell a Qualified Mortgage on the secondary market. As you may recall, the practice of packaging and reselling risky mortgages was one of the key causes of the 2008 financial crisis.
How a Qualified Mortgage Is the Same as Other Mortgages
The one major thing that isn't addressed by the requirements for a Qualified Mortgage is the loan's interest rate. As with any other mortgage, the interest rate that you receive with your Qualified Mortgage will be based on your credit history and your credit score. Having a record of on-time payments and a low level of debt will help you to qualify for a mortgage with the lowest interest rates, regardless of whether the loan meets the standard of a Qualified Mortgage.
And as with any other loan, you will want to carefully review the terms and conditions of a Qualified Mortgage. If you are refinancing the loan on your primary residence, you still have three days after the closing to cancel the loan.
What Are the Advantages of a Qualified Mortgage?
You can think of a Qualified Mortgage as kind of a seal of approval. While it was designed to a set standard of a safe investments for lenders and other financial institutions, obtaining a Qualified Mortgage is also a way for borrowers to have additional confidence that they will be able to payback their loan.
What Are the Drawbacks?
While the higher standards of a Qualified Mortgage mortgage make it safer for lenders and borrowers alike, it can raise the bar a bit too high for some potential homeowners. In the past, some have been able to use a more risky mortgage to enter the housing market, and transition to a more traditional mortgage soon after.
When Should You Consider Getting a Non-Qualified Mortgage?
There may be some times when a borrower might want to consider a loan that doesn't meet the standards for a Qualified Mortgage. For example, a wealthy borrower might have a large amount of assets, but relatively little income. These borrowers might easily be able to rely on their liquidable investments to make their mortgage payments, but wouldn't meet the debt-to-income ratio requirements of a Qualified Mortgage.
There are also first-time home buyers with moderate or low income that might not be able to get a Qualified Mortgage. Buyers who meet this profile might be faced with the choice of a non-qualified mortgage, or none at all.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on October 16, 2017, and has been updated.