QRM Definition and Criteria
© 2012, Brandon Cornett, all rights reserved
A qualified residential mortgage is an exception to a rule. In the wake of the housing crisis that started in 2008, Congress passed the Dodd-Frank Act (full name: Dodd-Frank Wall Street Reform and Consumer Protection Act).
Among other things, this act requires banks and mortgage lenders to retain 5% of the mortgage loans that they bundle and sell into the secondary mortgage market. This is referred to as "risk retention," since they are retaining some of the risk associated with long-term mortgages. Most banks prefer to sell the majority of their loans, as it absolves them of the long-term risk associated with those loans.
In response to concerns and complaints about this new requirement, Congress created an exception to the rule. The qualified residential mortgage (QRM) is the exception. If a mortgage loan meets certain criteria, it is exempt from the risk-retention rule mentioned above. Therefore, if most of a lender's loans meet the QRM criteria, the lender can bundle and sell most of its loans. This gives lenders an incentive to adhere to these guidelines, as much as possible.
The criteria and definition of the qualified residential mortgage have yet to be finalized. Thus, we are limited in the amount of specific information we can provide (for now). With that being said, the QRM is slowly taking shape. Here are some of the criteria we expect to see when the QRM is finalized:
October 6, 2012: We are waiting for input from the Consumer Financial Protection Bureau (CFPB) on the exact details of the qualified residential mortgage. We expect to have this information by the end of January 2012. This page will be updated and expanded as soon as we receive further information.
Editor's note: At this stage, we feel it is irresponsible to assign numbers to the criteria listed below, as other publishers have done (the NAR among them). There have been numerous proposals on these criteria. But those numbers could very well change before the QRM definition is finalized. When the QRM definition and criteria are finalized, we will update this entire website to reflect those criteria.
While the exact definition of the QRM has yet to be finalized, the Dodd-Frank Act does outline some of the key criteria to be included under this definition. Those items include, but are not limited to, the following:
- Documentation — Lenders will be required to verify the borrower's financial resources that are being used to qualify for the loan. This includes the borrower's income and other financial assets. While the exact documentation requirements have not yet been finalized, they will likely include the 'usual suspects' -- bank statements, tax records, and other financial records pertaining to investments and assets. We expect the QRM documentation requirements to be similar to those currently used for conforming loans.
- Debt Ratios — Lenders must consider the ratio of the borrower's monthly housing payments to the borrower's monthly income. In the mortgage industry, this is referred as the debt-to-income ratio (DTI). The limit or cap for the DTI ratio on qualified residential mortgage has yet to be determined. One proposal was to limit the mortgage payment to 28% of the borrower's gross monthly income.
- ARMs — If the borrower is using an adjustable-rate mortgage (ARM), the loan should "mitigate the potential for payment shock ... through product features and underwriting standards." Payment shock occurs when the monthly payment on an ARM loan increases significantly from one adjustment period to the next. An example of a mitigating feature would be to place a limit on the amount the monthly payments can increase when the ARM loan's interest rate rises.
- Insurance — The loan would need a sufficient amount of mortgage guarantee to reduce the risk of default. Few details have been provided in this area.
- Prohibited Features — The definition of qualified residential mortgage also prohibits the use of negative amortization, balloon payments, interest-only payments, prepayment penalties, and "other features that have been demonstrated to exhibit a higher risk of borrower default."
Again, all of these requirements are intended to reduce the risk of default (failure to pay). That is the primary objective of the qualified residential mortgage / QRM concept. Through statistical analysis, all of the factors listed above have been shown to reduce the likelihood of borrower default. Thus, they will all be incorporated into the final definition of the QRM, to some degree.
Down Payments and Loan-to-Value (LTV) Ratios
QRM down-payment requirements have been the subject of endless debate, speculation and misinformation. Some websites claim the government will soon require 20-percent down payments for all qualified residential mortgages. But this is simply not true (at least, not at this time).
There have been many proposals regarding the loan-to-value requirements and, inversely, the down-payment requirements for QRM loans. But none have made it into the latest version of statutes, which is the basis for ongoing discussion.
As the Center for American Progress rightly explains: "Neither the QRM nor the QM statutory lists of factors to be considered include the size of the down payment or its inverse, the loan-to-value ratio."
* We will update this website to reflect any changes to these or other criteria.
What the QRM Means to Home Buyers and Borrowers
Many home buyers have never even heard the terms qualified residential mortgage or QRM. But they can still be affected by it. Above, we have explained why most lenders want to issue loans that meet the QRM criteria. It gives them an exception to a rule they find troubling. It allows them to sell a higher percentage of their mortgage loans into the secondary market, thereby reducing their long-term risks. As a result, the majority of lenders will impose these guidelines upon their customers. The customer in this scenario is the home buyer who needs to use a mortgage loan to buy a house.
The bottom line is that borrowers who fail to meet the basic criteria for a qualified residential mortgage will have a harder time finding a loan, when compared to borrowers who do meet those criteria. They might end up paying a higher interest rate, as well. Lenders claim that risk retention increases their operating costs. So they will likely charge more for loans that are subject to these rules. Financial analysts from J.P. Morgan Securities have estimated that borrowers might pay up to three percentage points more for loans that are subject to risk-retention (i.e., loans that don't meet the definition of a qualified residential mortgage).
So a home buyer who falls short of the minimum criteria for a qualified residential mortgage can be affected in two ways: (1) They will have a harder time qualifying for a home loan. (2) They will likely pay a higher interest rate on the mortgage, since their loan will be subject to the risk-retention rules described above. This is why consumers need to know about the new rules. The purpose of this website is to increase awareness of the qualified residential mortgage concept.