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What is a Qualified Mortgage?
In short, a Qualified Mortgage is a loan that meets a specific set of rules outlined by the government. Qualified mortgages are intended to be better and safer for borrowers, lenders and the investors that purchase mortgages as compared to the risky and more exotic loan products of the past. In January 2014, the government implemented guidelines that determine if a mortgage is a Qualified Mortgage (QM). The rules are designed to ensure that borrowers obtain mortgages that they can afford. The QM guidelines focus on the borrower’s ability to make their monthly payment, repay the mortgage over time and the key loan features. A loan qualifies as a Qualified Mortgage if it meets the following rules:
- A borrower’s debt-to-income ratio must be no greater than 50%. This means a borrower can spend a maximum of 50% of their monthly gross income on total monthly housing expense plus other monthly debt such as auto loan and credit card payments. Putting a cap on the debt-to-income ratio is designed to ensure that borrowers have enough money to pay their mortgage plus all the other expenses associated with owning a home. While 50% is the maximum debt-to-income ratio according to Qualified Mortgage guidelines, many lenders apply a lower ratio when determining what size mortgage you can afford. The lower the debt-to-income ratio, the lower the loan amount you qualify for.
- Use ourMortgage Qualification Calculator to determine what size mortgage you qualify for
- The loan term must be 30 years or less. Limiting the mortgage length to no longer than 30 years is a way to manage the financial obligation for borrowers and reduce the total interest expense you pay over the life of your mortgage. The longer the mortgage term, the more interest expense you pay. For example, a 40 year mortgage requires you to pay much more interest than a 30 year loan. Capping the mortgage term at 30 years prevents more borrowers from becoming overextended for a longer period of time.
- The loan cannot have an interest only period. In short, Qualified Mortgage rules do not allow interest only mortgages. While interest only loans offer borrower lower monthly payments during the initial interest only period, your monthly payment can increase significantly when you are required to pay both principal and interest. Plus, the mortgage rate for an interest only loan is subject to change, which could cause your monthly payment to go up even more. Qualified Mortgage guidelines prevent the potential for payment shock associated with interest only mortgages. Please note that although they are not classified as Qualified Mortgages, you can still get interest only mortgages from selected lenders.
- The loan cannot have a large balloon payment at the end of the loan. Qualified Mortgage guidelines do not allow balloon payments because many borrowers could either not afford to make the payment or could not refinance their loan. Mortgages with balloon payments are much riskier than standard loans because you do not pay down the entire principal loan balance over time. With a traditional 30 year fixed rate mortgage, your loan is repaid in full when you make your final monthly payment. A mortgage with a balloon payment requires the borrower to make a large lump sum payment at the end of the loan. This exposes borrowers to significant risk and they could potentially lose their home to foreclosure if they do not have sufficient funds to make the payment. Eliminating this product removes a risky financing option for borrowers.
- Review our Qualified Mortgage Scorecard Example to evaluate a borrower scenario that complies with QM guidelines
- The loan cannot have negative amortization. This means the principal balance of the loan may not increase over time. During the 1990s and 2000s there was a proliferation of mortgage programs that negatively amortized. Loan products such a Pay Option ARMs enabled borrowers to choose their monthly mortgage payment and potentially increase their loan amount depending on the payment option they chose. Increasing your mortgage balance ultimately leads to higher loan payments, more interest expense and potentially financial challenges for borrowers. Qualified Mortgage guidelines prohibit negative amortization so the loan balance can never increase or be greater than your initial principal amount. Eliminating negative amortization is supposed to lower the risk that borrowers get a mortgage they cannot afford to repay because the loan balance continues to go up. Negatively amortizing loan products are almost impossible to find in the aftermath of the real estate crisis.
- Limit to the upfront fees and expenses that a lender can charge. For loan amounts of $100,000 and higher the lender can charge a maximum of 3% of the loan amount in upfront fees and expenses. This Qualified Mortgage provision is designed to protect borrowers from predatory lending. In the past, some unscrupulous lenders charged borrowers excessive fees or closing costs. Inexperienced or uniformed borrowers were especially vulnerable to this unfortunate tactic. Limiting the fees lenders can charge is intended to reduce predatory lending and prevent borrowers from being overcharged on their mortgage.
Simply put, if a mortgage complies with the Qualified Mortgage guidelines, the lender will receive certain legal protections if they sell that loan to a government sponsored enterprise, such as Fannie Mae or Freddie Mac (lenders sell loans so that they can use the proceeds to make additional loans). If the loan does not meet the Qualified Mortgage guidelines then these government sponsored enterprises are not allowed to buy it, which exposes the lender to more risk both financially and legally.
The table below shows mortgage terms including interest rates, fees and APRs for QM loans. We recommend that you contact multiple lenders in the table and request loan proposals. Comparing lenders is the best way to find the program and mortgage that meet your needs.
It is important to note that just because a loan does not comply with Qualified Mortgage guidelines does not mean that the borrower does not qualify for the loan or that the lender will not make the loan. Many lenders offer mortgages to borrowers even if the borrower’s debt-to-income ratio exceeds the maximum limit outlined above, as long as the lender determines that the borrower can repay the loan. Additionally, lenders may also offer mortgage programs, such as interest only loans, that do not comply with the QM guidelines.
For mortgages that do not meet Qualified Mortgage regulations, lenders usually keep these loans on their books or sell them to different investors who are aware of their higher risk profile. From the borrower's standpoint, you should always fully understand the terms and features of your loan and if it qualifies as a Qualified Mortgage. If you get a loan that is not a Qualified Mortgage, be aware of the added risks involved and make sure you can afford the loan now and in the future.
Certain lenders actually specialize in Non-Qualified Mortgages, also known as non-QM loans. These lenders usually focus on credit-challenged borrowers or applicants with unique income, employment or financial circumstances. Private money lenders, also known as hard money lenders, usually focus on non-QM loans. Private money lenders offer alternative loan programs to borrowers who cannot qualify for a mortgage with a traditional lender.
Private money loans usually charge a much higher mortgage rate and fees and may also include more onerous terms such a prepayment penalty. You may also be required to make a larger down payment or have more equity in the property. Borrowers should be sure to understand the extra costs and terms required by private money loans and other non-QM mortgage products.
Use the FREEandCLEAR Lender Directory to search by loan program and lender type including traditional and private money lenders.
Sources
“What is a Qualified Mortgage?” CFPB. Consumer Financial Protection Bureau, August 1 2017. Web.
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