A qualified mortgage is a mortgage that meets all the consumer protection requirements outlined in the Dodd-Frank Act. A qualified mortgage has become the underwriting standard for the mortgage industry.
Let’s take a closer look at what a qualified mortgage is, how it works, and how it affects homebuyers so you can determine if it makes sense for your situation.
Definition and Example of a Qualified Mortgage
A qualified mortgage is a long-term loan for a home that meets all the consumer protection requirements outlined in the Dodd-Frank Act. A qualified mortgage is the underwriting standard for the mortgage industry.
Compared to other types of financial products, a qualified mortgage is fairly new. It was created in 2014 to increase the chances a borrower would be able to repay their loan. Under the Dodd-Frank Act, a qualified mortgage requires a lender to evaluate a borrower’s ability to pay back what they borrow. Borrowers, for their part, must meet strict requirements.
- Acronym: QM loan, QM
Let’s say you’re in the market for a house. If you work a fairly traditional job and have a good handle on your debt, a qualified mortgage as opposed to a non-qualified mortgage (which we’ll discuss in detail below) is likely your best bet. It can protect you from taking on a loan you can’t afford and help you avoid foreclosure.
The Dodd-Frank Act, officially known as the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act, was created in 2010 in response to the 2008 financial crisis. It’s purpose is to regulate financial markets and protect consumers.
How a Qualified Mortgage Works
There are certain rules lenders must meet for their product to be considered a qualified mortgage. First and foremost, the loan must be free of any risky features or temporarily low monthly payments at the start of the term.
It must also be clear of expensive upfront costs and loan terms that exceed 30 years. In addition, a qualified mortgage generally limits the acceptable debt-to-income ratio (how much you owe each month divided by how much you earn) to no more than 43%.
Lastly, it requires lenders to adhere to “ability to repay rules” or ask you about your finances so they determine in “reasonable and good faith” whether you can repay the loan.
Points and fees for a qualified mortgage must be capped at 3% for loans of $100,000 or more
Types of Qualified Mortgages
There are four types of qualified mortgages, including:
- General: A general qualified mortgage is one in which a lender makes a good-faith effort to ensure a borrower can repay their loan on time. It doesn’t have any risky features like negative amortization, includes borrower restrictions on income and debt, and places limits on points and fees. A borrower’s maximum debt-to-income ratio is 43%.
- Temporary: When a loan is known as a temporary qualified mortgage, it meets the same requirements of a general qualified mortgage. The difference between a general qualified mortgage and temporary qualified mortgage is that a temporary qualified mortgage is eligible for purchase or guarantee by Fannie Mae or Freddie Mac and isn’t subject to the 43% debt-to-income ratio threshold.
- Small creditor: A small creditor qualified mortgage is made by a small creditor or a mortgage lender with less than $2 billion in assets that originates fewer than 500 mortgages per year. It needs to meet the same requirements as a general qualified mortgage, except it is open to borrowers with any debt-to-income ratio.
- Balloon payment: Even though balloon payments typically aren’t allowed in qualified mortgages, small creditors in rural or underserved areas may offer a balloon payment qualified mortgage. This is the result of the Helping Expand Lending Practices in Rural Communities (HELP) Act.
Qualified Mortgage vs. Non-Qualified Mortgage
Unlike a qualified mortgage, a non-qualified mortgage doesn’t have to conform to standards in the Dodd-Frank Act. If you’re having trouble qualifying for a qualified mortgage, you may get approved for a non-qualified mortgage, which can accept alternatives to proof of income, such as bank statements or tax returns.
There are a number of situations in which a non-qualified mortgage might make sense for a buyer. If you’re an unconventional borrower—for example, because you’re self-employed and your income fluctuates from month to month—a non-qualified mortgage can help you secure the financing you need to buy a home. It may also be a good fit if you don’t have the best credit or have gone through bankruptcy or foreclosure.
While a qualified mortgage won’t have any risky features like an interest-only period, negative amortization, or balloon payments, a non-qualified mortgage could have those features.
Even though interest rates vary from lender to lender, they tend to be higher with non-qualified mortgages, which have looser restrictions.
- A qualified mortgage, now the industry standard, meets the lender and borrower standards in the Dodd-Frank Act.
- A qualified mortgage is designed to increase the likelihood of borrowers repaying their loans.
- If you’re not eligible for a qualified mortgage, you may opt for a non-qualified mortgage, which may come with risky features and higher interest rates.