What is a Qualified Mortgage?

A Qualified Mortgage is a type of mortgage loan that meets certain criteria set by the Consumer Financial Protection Bureau (CFPB) to ensure that borrowers have the ability to repay the loan. Qualified mortgages must adhere to specific underwriting standards, such as limitations on loan terms and fees, and cannot include risky features such as interest-only payments or negative amortization. Lenders that originate qualified mortgages receive certain legal protections under the Ability-to-Repay rule, which helps shield them from liability in the event of borrower default.

A qualified mortgage (QM) is a category of loans that have certain, more stable features that help make it more likely that borrowers will be able to afford their loans. Defined under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in response to the 2008 financial crisis, qualified mortgages are intended to reduce risky lending practices and protect consumers from borrowing more than they can afford. Here’s an overview of what makes a mortgage "qualified" and the benefits for both borrowers and lenders.

Features of a Qualified Mortgage

**1. Prohibited Features:

• No Excessive Upfront Fees: QMs are designed to limit points and fees that borrowers must pay at or before closing. Typically, these cannot exceed 3% of the loan amount for loans above $100,000.
• No Toxic Loan Features: Qualified mortgages cannot include risky features such as terms that exceed 30 years, interest-only payments that don’t reduce the principal balance, or negative amortization payments where the principal balance increases.

**2. Cap on Debt-to-Income Ratio (DTI):

• DTI Limits: For a mortgage to qualify as a QM, a borrower's DTI ratio is usually required to be no higher than 43%. This means monthly debt payments cannot exceed 43% of the borrower's monthly gross income.

**3. Consideration and Verification of Borrower's Financial Information:

• Income and Assets: Lenders must verify borrowers’ income and assets to ensure they can realistically afford the mortgage payments.

Benefits for Borrowers

**1. Safer Borrowing:

• Lower Risk of Default: The stringent requirements to qualify for a QM ensure that borrowers are not approved for loans they cannot afford, reducing their risk of defaulting on their mortgage.

**2. Transparent Lending:

• Clearer Loan Terms: QMs require lenders to provide clearer terms and conditions, which helps borrowers understand exactly what they are agreeing to and reduces the likelihood of surprises related to loan payments.

**3. Long-Term Affordability:

• Stable Payment Structures: The absence of risky loan features such as negative amortization or interest-only payments ensures that borrowers have more predictable, stable mortgage payments.

Benefits for Lenders

**1. Legal Protections:

• Presumption of Compliance: Issuing QMs provides lenders with certain legal protections. Specifically, QMs are presumed to comply with the ability-to-repay rule set forth by the Dodd-Frank Act, giving lenders a legal shield against litigation claiming failure to assess the borrower’s ability to repay the loan.

**2. Reduced Risk:

• Lower Default Rates: Since QMs require a thorough check of a borrower's ability to repay, the risk of default is significantly lower compared to non-QM loans.

**3. Market Stability:

• Confidence in the Mortgage Market: By adhering to QM standards, lenders contribute to the overall health and stability of the housing market, which benefits the broader economy.

Conclusion

Qualified mortgages offer a framework for safer, more reliable lending that protects both the borrower and lender. For borrowers, QMs provide safeguards against risky loan features and ensure affordability, while for lenders, they reduce the risk of borrower default and provide legal protections. In sum, QMs are designed to promote a stable, transparent, and fair mortgage lending environment.