Qualified Mortgage (QM): Proposed Rules and Requirements
© 2012, Brandon Cornett, all rights reserved
People sometimes use the terms 'qualified mortgage' (QM) and 'qualified residential mortgage' (QRM) interchangeably. But they are not the same thing. They are born from the same piece of legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act.
While their names are similar, these are actually two variations of the same set of rules. Most of this website pertains to the QRM in particular, hence the name of the website. This page, however, is all about the QM. It is our hope that by having both terms defined on this website, we may reduce some of the confusion people have on this subject.
Difference Between QM and QRM
Perhaps it is best to start with a graphical overview of the QRM and QM rules.
As you can see from this diagram, both of these rules have their roots in the Dodd-Frank Act. The qualified mortgage (QM) is designed to reduce the risk of borrower default by requiring certain standards on home mortgage loans. In particular, the QM focuses on the borrower's ability to repay the loan. When finalized, it will require mortgage lenders to verify financial documents to ensure borrowers have a "reasonable ability to repay the obligation." The obligation in this context is the mortgage loan.
Unfortunately, the standards and guidelines for QM loans are still being finalized. So we cannot offer an exact definition of the qualified mortgage at this time. But there are certain things we know about it. Below, you will find the general framework of the QM, as defined in the Dodd-Frank Act.
The Qualified Mortgage, Defined by the Dodd-Frank Act
What is the definition of a qualified mortgage, and what rules are associated with it? Bearing in mind that the rules are still in a proposed, non-finalized state, here is what it says in Section 1412 of the Dodd-Frank Act.
The term 'qualified mortgage' means any residential mortgage loan that meets the following criteria:
- If the borrower makes regular payments on the loan, the principal balance may not increase.
- On a qualified mortgage, the borrower may not defer repayment of the principal amount borrowed. In other words, no interest-only loans. See exceptions below
- A qualified mortgage may not lead to the borrower having 'balloon payments.' In this context, a balloon payment is more than double the size of previous payments. See exceptions below
- On a qualified mortgage, the lender must properly verify and document the borrower's income (and other assets) used to qualify for the loan. The exact documentation requirements are forthcoming.
- If the qualified mortgage has a fixed interest rate, the payment schedule must fully amortize during the loan's term. This means that if the borrower makes all scheduled payments on time, the loan balance must be fully paid off at the end of the term.
- If the qualified mortgage has an adjustable interest rate, and the loan's underwriting "is based on the maximum rate permitted under the loan during the first 5 years," the payment schedule must fully amortize (be reduced) during the loan's term.
- A qualified mortgage must adhere to pre-established guidelines regarding debt-to-income ratios. In this context, the debt-to-income ratio is a comparison between the borrower's total monthly debt and his or her monthly income. [Note: This is one of the areas that have yet to be finalized. We expect additional details by January 2013.]
- With a qualified mortgage, the combined points and fees assigned to the loan cannot exceed 3% of the total loan amount. In this context, points and fees are additional charges made by the lender for the origination and processing of the loan, above and beyond the principal amount borrowed. This rule only applies to points and fees charged by the lender / loan originator. Fees charged by third parties other than the mortgage originator are excluded from the 3% rule.
- In general, the term (or payback period) of the loan cannot exceed 30 years. [Note: It appears there will be exceptions to this rule, as well. But we are unclear as to what those exceptions are. We hope to receive clarification when the qualified mortgage rules are finalized, by January 2013.]
Exceptions to the Rules
Two of the proposed qualified mortgage rules shown above have an exception listed after them. The following exceptions have to do with balloon loans. A balloon loan has monthly payments that increase over time, usually as the result of interest-only payments where the borrower defers payment of the principal amount borrowed. Under the currently proposed guidelines (which may change before January 2013), a balloon loan could be considered a qualified mortgage if it meets the following requirements:
BALLOON LOANS.--The Bureau may, by regulation, provide that the term "qualified mortgage" includes a balloon loan--
(i) that meets all of the criteria for a qualified mortgage under subparagraph (A) (except clauses (i)(II), (ii), (iv), and (v) of such subparagraph);
(ii) for which the creditor makes a determination that the consumer is able to make all scheduled payments, except the balloon payment, out of income or assets other than the collateral;
(iii) for which the underwriting is based on a payment schedule that fully amortizes the loan over a period of not more than 30 years and takes into account all applicable taxes, insurance, and assessments; and
(iv) that is extended by a creditor that-
(I) operates predominantly in rural or underserved areas;
(II) together with all affiliates, has total annual residential mortgage loan originations that do not exceed a limit set by the Bureau;
(III) retains the balloon loans in portfolio; and
(IV) meets any asset size threshold and any other criteria as the Bureau may establish, consistent with the purposes of this subtitle.
The blockquoted portion of text above was copied verbatim from the Section 1412 of the Dodd-Frank Act, subparagraph 'E.'
Note: This page will be completely updated on or before January 2013, when the qualified mortgage (QM) rules are finalized by the Consumer Financial Protection Bureau.