Qualified Mortgage
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What You Should Know
- A qualified mortgage adheres to the requirements listed in the qualified mortgage rule that limits the risk of borrowers and liability of lenders.
- A qualified mortgage rule was issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act after the financial crisis of 2008.
- The main benefit of a qualified mortgage to a borrower is that they get a mortgage that they are able to repay.
What Is a Qualified Mortgage?
A qualified mortgage is a type of mortgage that adheres to the Bureau of Consumer Financial Protection’s qualified mortgage rule. Qualified mortgage rule (QM Rule), also known as the ability-to-repay (ATR) rule, requires a lender to make a reasonable determination of a borrower’s ability to make repayments for a mortgage. A qualified mortgage rule does not apply to all mortgages. It only applies to qualified mortgages that tend to provide more protection against default for both lenders and borrowers. If a lender issues a qualified mortgage, this means that the lender adheres to certain requirements and follows the ability-to-repay rule.
| Features of Qualified and Unqualified Mortgages | ||
|---|---|---|
| Features | Qualified Mortgage | Unqualified Mortgage |
| Discount Points and Fees | Limited Based on Loan Value | Not Limited |
| Debt-to-Income Ratio | No More Than 43% | Up to a Lender |
| Risky Features | Restrictions Apply | No Restrictions |
A qualified mortgage rule was issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. This provision is intended to protect borrowers and financial markets from risky lending practices that were responsible for the subprime mortgage crisis of 2007 - 2008. The goal of the act is to lower the risk of newly created mortgages.
There are certain rules that a qualified mortgage has to adhere to:
- Some Loan Features Are Not Allowed
There are many loan features that can make a mortgage much riskier for both lenders and borrowers. Some of these features include interest-only payment periods, balloon payments, negative amortization, and a term length of more than 30 years. Usually, a qualified mortgage loan is a fully amortized loan with monthly payments that are determined based on the income of the borrower. This way, a lender and a borrower are certain how much is needed to be paid every month and whether a borrower can afford the payments.
- Loan Approval Based on Debt-to-Income Ratio
The goal of a qualified mortgage rule is to ensure that the borrower can afford to make their debt payments. A qualified mortgage looks closely at the debt-to-income (DTI) ratio to determine how big of a loan a borrower can get. The DTI ratio limit is set to 43%, which means that a borrower may be able to get a loan as long as their monthly debt payments do not exceed 43% of their monthly income. This ratio does not simply look at the mortgage payments. DTI usually includes all debt payments that need to be made in a certain period. Some loans, such as DSCR mortgages, may not satisfy the debt-to-income ratio requirement, which makes them not qualified.
- Points and Fees Limitations
Another unique characteristic of qualified mortgage loans is the limit set on how much a borrower has to pay upfront for fees and discount points. This rule protects the borrower from overpaying for their mortgage upfront. The limits on the fees and points are determined based on the loan value. The limits are adjusted annually for inflation based on the CPI-U.
| Loan Amount | Maximum Fees and Points Payments |
|---|---|
| Over $100,000 | 3% |
| $60,000 - $100,000 | $3,000 |
| $20,000 - $60,000 | 5% |
| $12,500 - $20,000 | $1,000 |
| Less Than $12,500 | 8% |
How Does Qualified Mortgage Work?
A borrower and a lender must meet certain financial requirements to be eligible for a qualified mortgage. They mostly focus on the ability of a borrower to pay off their debt in a timely manner. These requirements include:
- Borrower’s debt-to-income ratio of no more than 43%.
- Lender’s fees and discount points do not exceed the set amount based on the loan value.
- There are no risky features such as interest-only payment periods, negative amortization or balloon payments.
These requirements restrict lenders from issuing an excessive amount of loans, but there is also a benefit for a lender to comply with the requirements. In some cases, a borrower may file a lawsuit against the lender if the lender had no reason to believe that the borrower would be able to pay off the loan. A qualified mortgage rule protects a lender against lawsuits by distressed borrowers.
Why Do Lenders Issue Qualified Mortgages?
There is a clear benefit of qualified mortgages for consumers and the whole financial system in general. On the other hand, it is less clear why a lender would choose to issue qualified mortgages because they have to adhere to all restrictions set for a mortgage to be considered qualified. These restrictions will directly affect the income of the lenders because they may not be able to issue as many loans as they would, and they would not get as high a return on their loan.
One of the reasons why a lender may choose to issue qualified mortgages is the legal protection it provides. A borrower who suspects that their lender had no reason to believe that they could pay off their mortgage, may file a lawsuit against the lender. In this case, the lender risks losing their time and money. On the other hand, qualified mortgage borrowers do not have the ability to file a lawsuit if they are in financial distress. In this case, the lender does not need to worry about wasting their resources on court hearings.
Additionally, due to their relatively low risk, there is a large secondary market for this type of loan. Because of a large market, qualified mortgages tend to be quite liquid, so a lender may be able to sell the mortgage to other investors fast. One common strategy lenders pursue is they sell the loan shortly after its origination. When it is sold to the secondary market, multiple loans are combined into mortgage-backed securities and are sold to various institutional investors such as hedge funds and pension funds. The contrary to this are portfolio loans, which are held by lenders until maturity.