Most every mortgage loan issued today is a loan lenders refer to as a Qualified Mortgage Loan (or QM). When the Consumer Financial Protection Bureau, or CFPB, was created one of the first set of guidelines issued was to establish common sense, universal lending requirements mortgage companies could follow when processing and approving a mortgage application. These new guidelines took effect back in January of 2014 and are still in force today. To define a Non-Qualified Mortgage (non-QM) loan also means defining a Qualified Mortgage.
Qualified Mortgage vs. Non-Qualified Mortgage
A loan that meets QM requirements provides lenders who approve loans using QM standards what is known as “safe harbor” which protects lenders from frivolous lawsuits and protects consumers knowing the borrowers have demonstrated an ability to repay the new mortgage plus current monthly credit obligations. The “ability to repay” is actually a term used within the QM guidelines which means total monthly debt cannot exceed 43 percent of a borrower’s gross monthly income. At this level, it has been shown that the risk of default on any debt is low. Other features of a QM loan include a restriction on the amount of upfront fees, balloon payments and what is referred to as negative amortization.
A non-QM loan is one that carries one or more of these features. For example, there can be no loans with a balloon payment. This is a loan where the borrowers make regular monthly payments for the first few years yet at the end of a specific term, the entire loan balance is due immediately. A loan with a balloon payment such as this does not qualify for QM status.
How it Works
Mortgage loans today are typically “fully amortized” which means part of each monthly payment goes toward interest due the lender and toward the loan balance. Making these regular payments over time will eventually pay off the loan completely. A negative amortization loan is one that permits borrowers to choose an amount to pay each month. The loan might specify a monthly payment that carries both principal and interest but allows for an interest-only payment. If the principal isn’t paid that month, it gets added back to the loan balance, causing the loan to grow instead of getting smaller. Negative amortization makes a loan ineligible for QM designation.
Loans that are underwritten to FHA, VA and USDA guidelines can obtain QM status as do loans that are approved using Fannie Mae and Freddie Mac guidelines. However, it’s important to note that just because a loan isn’t considered a qualified mortgage, that doesn’t mean the loan is bad for the consumer.
For example, a perfectly good borrower with excellent credit could obtain a loan approval with debt ratios higher than 43. Say a borrower has applied for a loan with a debt ratio of 45, higher than the 43 ability to repay rule. The lender can still approve the loan. The CFPB simply says lenders are required to make a reasonable effort to determine if a borrower can repay the new mortgage based upon verification of employment, income, assets, debt and credit.
The QM rule was put into place to provide stability in the mortgage marketplace and the markets have responded well. A non-Qualified Mortgage (non-QM) loan demands a bit more scrutiny but is not necessarily a bad loan.