A Qualified Mortgage (QM) is a category of mortgage loan that meets specific criteria set by the Consumer Financial Protection Bureau (CFPB) under the Dodd-Frank Wall Street Reform and Consumer Protection Act. These criteria are designed to ensure that lenders issue loans that borrowers have the ability to repay, thus reducing the risk of defaults and promoting responsible lending practices.

Key Characteristics of a Qualified Mortgage:

1. Ability-to-Repay Rule:
   • One of the fundamental requirements for a loan to be considered a Qualified Mortgage is that the lender must verify and document the borrower’s ability to repay the loan. This includes assessing the borrower’s income, assets, employment status, credit history, and monthly expenses.
2. Prohibited Loan Features:
   • Qualified Mortgages cannot have certain risky features that were common in loans issued before the financial crisis, such as:
     • No Interest-Only Payments: The loan cannot be structured with payments that cover only interest, without reducing the principal.
     • No Negative Amortization: The loan cannot allow for payments that are less than the interest due, resulting in an increasing loan balance.
     • No Balloon Payments: Large, lump-sum payments that are due at the end of the loan term are not allowed, except in certain types of small creditor loans.
     • No Loan Terms Longer than 30 Years: The loan term cannot exceed 30 years.
3. Points and Fees Limitation:
   • The points and fees charged by the lender must not exceed 3% of the loan amount for loans greater than $100,000. For smaller loans, slightly higher percentages are allowed. This limitation helps prevent excessively expensive loans.
4. Debt-to-Income Ratio (DTI):
   • For a mortgage to qualify as a QM, the borrower’s debt-to-income ratio generally cannot exceed 43%. This means that the borrower’s total monthly debt payments, including the mortgage, should not exceed 43% of their gross monthly income.
5. Safe Harbor and Rebuttable Presumption:
   • Qualified Mortgages can provide lenders with a “safe harbor” or “rebuttable presumption” of compliance with the ability-to-repay rule:
     • Safe Harbor: Loans that meet the QM standards and are not higher-priced loans are presumed to comply with the ability-to-repay requirements, offering the lender strong protection against borrower lawsuits.
     • Rebuttable Presumption: Higher-priced loans that meet QM standards offer lenders a rebuttable presumption of compliance, meaning that borrowers could challenge the loan in court if they believe the lender failed to consider their ability to repay.
6. Types of Qualified Mortgages:
   • General QM: Loans that meet the basic QM criteria, including the 43% DTI requirement.
   • Temporary QM: Loans that meet the QM criteria but are also eligible for purchase by government-sponsored enterprises (GSEs) like Fannie Mae or Freddie Mac, or are insured by government agencies like the FHA, VA, or USDA.
   • Small Creditor QM: Loans issued by smaller lenders (those with less than $2 billion in assets and originating 500 or fewer first-lien mortgages per year) can qualify under slightly different rules.

Example:

A borrower applies for a 30-year fixed-rate mortgage with a 4.5% interest rate. The lender verifies the borrower’s income, assets, and employment status, and determines that their debt-to-income ratio is 40%. The loan does not have any risky features, such as interest-only payments or negative amortization, and the points and fees do not exceed 3% of the loan amount. Because the loan meets all the criteria, it is considered a Qualified Mortgage.

Importance:

• Consumer Protection: Qualified Mortgages are designed to protect borrowers by ensuring that lenders make loans only to those who have the ability to repay them, reducing the likelihood of foreclosure.
• Lender Security: By issuing Qualified Mortgages, lenders can reduce their legal risk, as these loans are presumed to comply with the ability-to-repay rule.
• Market Stability: Qualified Mortgages contribute to the overall stability of the mortgage market by promoting responsible lending and reducing the prevalence of high-risk loans.

A Qualified Mortgage is a type of mortgage that meets specific regulatory standards aimed at ensuring the borrower’s ability to repay, protecting both the borrower and the lender, and promoting stability in the housing market.