What is a Qualified Mortgage?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated November 6, 2020

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.