What Is a Qualified Mortgage?
A qualified mortgage is a mortgage that meets certain requirements for lender protection and secondary market trading under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a significant piece of financial reform legislation passed in 2010.
Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act are intended to protect both borrowers and the financial system from the risky lending practices that contributed to the subprime mortgage crisis of 2007. By creating greater incentives for offering higher quality mortgage loans in both the primary and secondary markets, the goal of the act was to lower the overall risk that mortgages create in the greater financial system.
Key Takeaways
- A qualified mortgage is a mortgage that meets certain requirements for lender protection and secondary market trading under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
- Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act—which was passed in 2010 and created the rules that regulate qualified mortgages—are intended to protect both borrowers and the financial system from the risky mortgage lending practices that contributed to the subprime mortgage crisis of 2007.
- To be eligible for a qualified mortgage, borrowers must meet certain requirements; these requirements are meant to determine a borrower's ability to repay their mortgage.
How Qualified Mortgages Work
To be eligible for a qualified mortgage, there are certain requirements that borrowers must meet. These requirements are based on an analysis of the borrower's ability to repay their mortgage (according to their income, assets, and debts). These parameters require that the borrower has not taken on monthly debt payments in excess of 43% of pre-tax income; that the lender has not charged more than 3% in points and origination fees; and that the loan has not been issued as a risky or overpriced loan with terms such as negative-amortization, balloon payment, or interest-only mortgage.
For lenders who follow certain regulations laid out in the Act, qualified mortgages may provide them with certain additional legal protections. Under qualified mortgage rules, “safe harbor” provisions protect lenders against lawsuits by distressed borrowers who claim they were extended a mortgage the lender had no reason to believe they could repay.
They also provide incentives for lenders who wish to sell their loans in the secondary market (since qualified mortgage loans are more appealing to underwriters in structured product deals). Lenders who issue qualified mortgages can more easily resell them in the secondary market to entities such as Fannie Mae and Freddie Mac. These two government-sponsored enterprises buy most mortgages, which frees up capital for banks to make additional loans.
Qualified mortgage rules were developed to help improve the quality of loans issued in the primary market (and that ultimately may become available for trading in the secondary market). The majority of newly-originated mortgages are sold by the lenders into thesecondary mortgage market. In the secondary mortgage market, newly-originated mortgages are packaged into mortgage-backed securities and sold to investors, such as pension funds, insurance companies, and hedge funds. Only certain qualified mortgages are eligible for sale in the secondary market.
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for homebuyers with lower credit scores, such as those below 640. Another change: Your down payment will influence what your fee is. The higher your down payment, the lower your fees, though it will still depend on your credit score. Fannie Mae provides the Loan-Level Price Adjustments on its website.
Special Considerations
There are several exceptions to qualified mortgage rules. One exception is that points and origination fees may exceed 3% for loans of less than $100,000. (Otherwise, lenders might not be sufficiently compensated for issuing such loans, and these smaller mortgages might become unavailable.)
In addition, qualified mortgage regulations permit lenders to issue mortgages that are not qualified. However, there are rules that limit the sale of these loans into the secondary mortgage market and provide fewer legal protections for lenders.
FAQs
A qualified mortgage is a home loan that meets federal guidelines aimed at preventing lenders from issuing loans that borrowers can't afford to repay. These guidelines were created in the wake of the 2008 financial crisis and are designed to be less risky for borrowers and lenders alike.
What does qualified mortgage mean? ›
A Qualified Mortgage is a category of loans that have certain, less risky features that help make it more likely that you'll be able to afford your loan. A lender must make a good-faith effort to determine that you have the ability to repay your mortgage before you take it out.
What is the 3% rule for QM? ›
Mandatory product feature requirements for all QMs
Points and fees are less than or equal to 3% of the loan amount (for loan amounts less than $100k, higher percentage thresholds are allowed); No risky features like negative amortization, interest-only, or balloon loans (BUT NOTE: Balloon loans originated until Jan.
What is the mortgage qualification rule? ›
Employment record: The requirements vary by lender, but typically, you'll need to provide evidence of steady employment from the past two years. Credit score: For a conventional loan, you'll need at least a 620 FICO score. If you don't qualify, you might consider an FHA loan, which allows scores as low as 580.
What features are permitted in a qualified mortgage? ›
These parameters require that the borrower has not taken on monthly debt payments in excess of 43% of pre-tax income; that the lender has not charged more than 3% in points and origination fees; and that the loan has not been issued as a risky or overpriced loan with terms such as negative-amortization, balloon payment ...
What is the debt-to-income ratio for a qualified mortgage? ›
Backed by the federal government, Federal Housing Administration loans offer financing assistance to homebuyers with lower credit scores or smaller down payments. Most borrowers need a DTI of 43% or less to qualify for an FHA loan.
Is a 40-year mortgage a qualified mortgage? ›
40-year mortgages aren't “qualified mortgages,” meaning they don't follow a set of rules created by the Consumer Financial Protection Bureau (CFPB). Mortgages with a loan term of longer than 30 years, negative amortization or other risky features don't meet the standards of qualified mortgages.
What are QM requirements? ›
General definition category of QMs
Any loan that meets the product feature requirements with a debt-to-income ratio of 43% or less is a QM.
What are the four types of QM loans? ›
There are four types of QMs – General, Temporary, Small Creditor, and Balloon-Payment. Of the four types of QMs, two types – General and Temporary QMs – can be originated by all creditors. The other two types – Small Creditor and Balloon-Payment QMs – can only be originated by small creditors.
How is qm calculated? ›
Under the amended rule, a loan will meet the General QM definition if the Annual Percentage Rate (APR) exceeds the Average Prime Offer Rate (APOR) for a comparable transaction by less than 2.25% (or up to 6.5% depending on the loan amount and transaction type) at the time the interest rate is set.
FHA provides mortgage programs with lower requirements. This makes IT easier for most borrowers to qualify, even those with questionable credit history and low credit scores. FHA loans offer low interest rates to help homeowners afford their monthly housing payments.
What ratio Cannot exceed for a qualified mortgage? ›
For General QMs, the ratio of the consumer's total monthly debt to total monthly income (DTI or DTI ratio) must not exceed 43 percent.
How is income calculated for mortgage qualification? ›
Calculating the qualifying income for a salaried employed is fairly straightforward. Take the gross annual salary amount and divided it by 12 months. There are loan programs where a salaried employ can close on a home loan before actually starting with the new employer.
What are the benefits of a qualified mortgage? ›
Pros. Helps ensure affordability: While your situation can change after you get approved, qualified mortgages have strict guidelines to ensure that you can afford your monthly payments based on your financial situation when you apply for the loan.
What is the new qualified mortgage rule? ›
The Ability-to-Repay/Qualified Mortgage Rule (ATR/QM Rule) requires a creditor to make a reasonable, good faith determination of a consumer's ability to repay a residential mortgage loan according to its terms.
What is the final rule for QM? ›
The General QM Final Rule
Under the amended rule, a loan meets the General QM loan definition only if the annual percentage rate (APR) exceeds the average prime offer rate (APOR) for a comparable transaction by less than 2.25 percentage points as of the date the interest rate is set.
What is the difference between qualified and nonqualified interest mortgage? ›
Limits on debt-to-income ratio
In most cases, a qualified mortgage borrower is limited to a 43 percent DTI ratio. In contrast, non-QM loans are not subject to these same rules and regulations. They typically have less stringent requirements for credit scores, debt-to-income ratios and repayment schedules.
What is a non-qualified mortgage? ›
Non-QM loans are aimed at borrowers with financial profiles that don't meet the requirements of a typical qualified mortgage. This often involves an inconsistent or nontraditional income structure, a major credit event or high debt. Features associated with non-QM loans include: Alternative income documentation.
What are the three general categories that define a qualified mortgage? ›
As described below, a loan that meets the product feature requirements can be a QM under any of three main categories: (1) the general definition; (2) the “GSE-eligible” provision; or (3) the small creditor provision.
