Qualified Mortgage

A Qualified Mortgage (QM) refers to a category of loans that have certain, more stable features that help make it more likely that a consumer will be able to afford their loan. Under U.S. federal law, this concept was introduced by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Mortgage lenders, as mandated by the Consumer Financial Protection Bureau (CFPB), are obliged to follow specific rules when determining if a mortgage qualifies as a QM. These rules are designed to protect consumers from risky loan features and to ensure that lenders conduct a meaningful assessment of a borrower’s ability to repay the loan.

Key Characteristics of a Qualified Mortgage

  1. Debt-to-Income Ratio: One of the principal features of a Qualified Mortgage is the limit on the borrower’s debt-to-income (DTI) ratio. This ratio should generally be 43% or less for a loan to be considered a Qualified Mortgage.
  2. No Toxic Loan Features:
    • No Interest-Only Periods: Loans where the borrower only pays interest without reducing the loan principal.
    • No Negative Amortization: Loans where the principal amount increases over time, even when payments are made on time.
    • No Balloon Payments: Large, one-time payments at the end of the loan term are forbidden with certain exceptions.
  3. Term Limitations: The loan term should not exceed 30 years.
  4. Points and Fees Limitation: Points and fees must be below 3% of the loan amount for loans of $100,000 or more. Smaller loans have greater flexibility.
  5. Documentation and Verification: Lenders must thoroughly document and verify a borrower’s income, assets, and liabilities.

Importance of Qualified Mortgages

The primary aim of QM is to ensure that loans are more stable and secure both for consumers and the broader financial system. By eliminating high-risk loan features and ensuring that lenders take due diligence in verifying a borrower’s ability to repay, QMs help mitigate the risk of defaults and foreclosures. This contributes to a more stable housing market and a more resilient financial system.

The concept of Qualified Mortgages underscored the broader effort of financial reforms initiated post the 2008 financial crisis, focusing on ensuring responsible lending practices.

Types of Qualified Mortgages

There are several types of Qualified Mortgages, including:

  1. General QM: General QM loans follow the guidelines set forth by the Ability-to-Repay (ATR) rule, which include the cap on DTI ratio and verification of income/credit history.
  2. GSE-Eligible QM: Loans eligible for purchase by Government Sponsored Enterprises (GSEs) like Fannie Mae or Freddie Mac, qualifying under their respective underwriting guidelines.
  3. Small Creditor QM: This category allows certain smaller lenders who underwrite loans to retain slightly more leniencies with the provision that loans stay within certain limits.
  4. Seasoned QM: A recent addition allows a non-QM loan to be reclassified as a QM after exhibiting a good payment history for a set period, usually three years.

The Consumer Financial Protection Bureau (CFPB) is the primary regulatory authority overseeing the implementation and compliance of Qualified Mortgage rules. They issue regular guidelines and updates to address the evolving market conditions and to improve consumer protections. The QM rule forms part of a broader regulatory framework, which includes the Ability-to-Repay rule.

Ability-to-Repay (ATR) Rule

The ATR rule requires lenders to make a good-faith effort to determine if a consumer can repay a mortgage before it’s approved. It obliges lenders to verify a borrower’s financial information and consider factors such as income, assets, debts, and credit history. Lenders must keep records showing they have made an ATR determination and consumers can sue lenders for failing to prove compliance with this rule.

Dodd-Frank Act

The QM concept was introduced by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act was enacted in response to the 2008 financial crisis, aiming to prevent the recurrence of such an economic breakdown. It introduced significant changes to financial regulation and credit requirements.

Effect on Borrowers and Lenders

For borrowers, Qualified Mortgages provide assurance that the loan terms are less risky and that the lender has assessed their ability to repay. This helps prevent over-borrowing and reduces the risk of foreclosure.

For lenders, originating a QM protects them from certain legal liabilities under the ATR rule. If a lender makes a QM, they are given a presumption, or even a safe harbor, that they have met the ATR requirements. This reduces the chances of costly litigation.

Challenges and Criticisms

Despite its benefits, the QM rule has faced criticisms and brought several challenges:

  1. Stringent Requirements: The strict criteria and documentation requirements may exclude certain borrowers, particularly those who are self-employed or have non-traditional income sources.
  2. Complexity: The QM rules add layers of complexity and increased compliance costs for lenders.
  3. Loan Accessibility: Some argue that QM rules, while protective, could make it harder for qualified borrowers to access mortgage credit.

Recent Developments

In recent years, the CFPB has considered adjustments to the QM rule to reflect changes in the housing market and economic conditions. For instance, the expiration of the GSE Patch (which allowed loans eligible for purchase by Fannie Mae and Freddie Mac to be QM regardless of the DTI ratio) prompted discussions on adjusting the DTI threshold and other criteria.

Additionally, the introduction of the Seasoned QM rule aims to provide a pathway for high-performing non-QM loans to gain QM status, thereby increasing the liquidity and marketability of such loans.

Conclusion

Qualified Mortgages play a crucial role in ensuring the stability and sustainability of the residential mortgage market. By enforcing stringent lending standards and focusing on the borrower’s ability to repay, they mitigate risks for both borrowers and lenders. The continuous evolution of QM guidelines reflects an ongoing commitment to balancing consumer protection with market growth and accessibility. For more detailed information on Qualified Mortgages and related rules, you can visit the Consumer Financial Protection Bureau’s official website at www.consumerfinance.gov.