A qualified mortgage is a type of loan with certain more stable features that help make it more likely that a borrower will be able to repay their loan. This doesn’t necessarily involve more work for the borrower, but it does mean that lenders will take a deeper dive into a potential borrower’s finances. The lender will analyze factors such as a borrower’s ability to repay to better determine if the mortgage they applied for is considered affordable for them under the guidelines.
Created in an effort to clamp down on the excessive risk-taking in the mortgage industry prior to 2008, the rule is intended to protect consumers from harmful practices. However, it may also make it harder to qualify under certain loan programs.
How Qualified Mortgages Work
Qualified mortgages follow three basic tenets, outlined by the Consumer Financial Protection Bureau (CFPB):
1. Borrowers should be able to pay back their loans.
2. A qualified mortgage should be easier for the borrower to understand.
3. The qualified mortgage should be a fair deal for the borrower.
Based on these ideas, the CFPB created stricter guidelines for loans that are not sold to Fannie Mae or Freddie Mac to ensure that borrowers could repay loans.
For these loans, there is a limit on how much of a borrower’s eligible income can go toward debt. In general, total monthly debts cannot exceed 43% of a borrower’s gross monthly income, a percentage referred to as a debt-to-income ratio (DTI). Limiting the amount of debt a borrower can take on makes them a safer bet for banks and less likely to default on their mortgage. Keeping the loan within a reasonable DTI ensures that a borrower is not borrowing more money than they can repay.
Next, the loan term on a qualified mortgage must be no longer than 30 years. Once again, this is in place to protect the home buyer. A loan term beyond 30 years is considered a riskier loan because the extended term means longer payback and additional interest — both key considerations when it comes to how to choose a mortgage term.
In addition, a qualified mortgage is barred from having some other risky features, such as:
• Interest-only payments: Interest-only payments are payments made solely on the interest of the loan, with no money going toward paying down the principal. When a borrower is only paying interest, they don’t make a dent in paying off the loan itself.
• Negative amortization: With amortization, the amount of the loan goes down with each regular payment, as is illustrated when using a mortgage calculator. In the case of negative amortization, however, the borrower’s monthly payments don’t even cover the full interest due on the mortgage. The unpaid interest then gets added to the outstanding mortgage total, so the amount owed actually increases over time. In some cases, depending upon market conditions, a borrower could end up owing more than the home is worth.
• Balloon payments: These are large, one-time payoffs due at the end of the introductory period of the loan, historically after five or seven years.
Additionally, qualified mortgages have certain limits on the points and fees that lenders are allowed to charge. A lender can only charge up to the following maximum fees and points on a qualifying mortgage; otherwise, it’s referred to as a high-priced mortgage, which carries additional guidelines:
• For a loan of $100,000 or more: 3% of the total loan amount
• For a loan of $60,000 to $100,000: $3,000
• For a loan of $20,000 to $60,000: 5% of the total loan amount
• For a loan of $12,500 to $20,000: $1,000
• For a loan of $12,500 or less: 8% of the total loan amount
Alongside caps on points and fees, there are also limits on the annual percentage rate (APR) that can be charged on a qualifying mortgage. This threshold can vary depending on the loan’s size or type.
Lastly, lenders must verify a borrower’s ability to repay the loan, so they’re not immediately scrambling to figure out how to lower mortgage payments. The ability-to-repay rule encompasses different aspects of a borrower’s financial history that a lender must review. Specifically, a lender is likely to review items such as:
• Income
• Assets
• Employment
• Credit history
• Alimony or child support, or other monthly debt payments
• Other monthly mortgages
• Mortgage-related monthly expenses (such as private mortgage insurance, homeowners association fees, or taxes)
Under some circumstances, however, lenders might not have to follow the ability-to-repay rule and the mortgage can still count as a qualified loan.
In addition to the protections provided to borrowers, the rule also grants lenders some protection. Qualified mortgages offer safe harbor to the lender if ability to repay rules were properly adhered to when qualifying the borrower(s) for the requested loan program. In these instances, borrowers can’t sue based on the claim that the institution had no basis for thinking they could repay their loans. The rules also make it harder for borrowers to buy more house than they can afford.
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What Is a Non-Qualified Mortgage?
A non-qualified mortgage (non-QM) is a type of mortgage loan that does not meet the standards required for a qualified mortgage, outlined above.
However, a non-QM loan is not the same as the subprime loans that were available before the housing market crash. Typically, with a non-QM loan, lenders confirm that borrowers can repay their loans based on reasonable evidence. This can include verifying much of the same information as qualified mortgage loans, such as assets, income, or credit score.
Non-qualified mortgage loans allow lenders to offer loan programs that don’t necessarily meet the strict requirements of qualified mortgages. Because non-QM loans don’t have to adhere to the same standards, it means the underwriting requirements, like the qualified mortgage DTI limit, can be more flexible.
The upside is that this can provide eligible borrowers with more loan program choices. That being said, non-qualified loans can vary by lender, so borrowers who take this route should research their options carefully and take advantage of tools like a home affordability calculator to help ensure they don’t get in over their head.
Recommended: Home Buying Guide
When Could a Non-QM Loan Be the Right Option?
While qualified mortgages have safeguards in place for both the lender and the borrower, in some circumstances, it can make sense for a borrower to choose a non-qualified mortgage.
Many lenders offer non-QM loan programs because they have more flexible loan features. In some instances, a borrower may opt for a non-QM loan because of property issues, such as a condo that doesn’t meet certain criteria or a certain property type.
This type of loan may be right for borrowers who can afford the mortgage but don’t conform to additional qualified-mortgage requirements. Examples of borrowers who might seek a non-qualified mortgage are:
• The self-employed: Borrowers with streams of income that might be difficult to document, like freelance writers, contractors, and others, might consider a non-qualified mortgage.
• Investors: People investing in real estate properties, including flips and rentals, might choose to apply for a non-qualified mortgage. This could be because they need funding faster or have a challenging time proving income from their rental properties.
• Non-U.S. residents: People who are not U.S. residents may find it challenging to meet the requirements for qualified mortgages because they may have a low or nonexistent credit score in the U.S.
While understanding the nitty-gritty of qualified mortgages vs. non-qualified mortgages might feel overwhelming, understanding the differences and other mortgage basics might make choosing the best loan fit for your needs easier. It’s important to do your research and ask lenders questions about the different loan programs available.
If you’re looking for a mortgage to fit your financial needs, consider checking out SoFi’s Mortgage Loans. Borrowers can put as little as 10% down for loans up to $3 million. And with competitive rates and dedicated mortgage loan officers, applying for a new home might be easier than you think.
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