There are two types of mortgages: qualified and non-qualified. The difference is whether or not the government agencies protect the lender against any type of lawsuit against them should a borrower become unable to afford their mortgage payments and want to sue.
Qualified vs Nonqualified Mortgage Loans
The government created measures to counter the impact of the most recent housing crisis. This was done specifically in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law by President Barack Obama in the summer of 2010.
Apart from implementing regulatory reform, the new law created minimum standards for mortgages. This includes the Ability to Repay rule and a definition for Qualified Mortgage Loans. These revisions were put into action on January 10, 2014, by the Consumer Financial Protection Bureau (CFPB).
All these changes have also led mortgage loans to be divided into two types: qualified and nonqualified. Let’s explore the differences between the two.
A Qualified Mortgage (QM) is a category where loans are more stable, with well-defined requirements. It is primarily intended to assist individuals who have been proven to afford a loan. The lender makes that effort to really determine that you, the borrower, have the financial ability to repay your mortgage even before you take it out. It does so by looking at documents like bank statements or a credit score report.
A Nonqualified Mortgage (non-QM), on the other hand, is the category that covers all those loans that don’t fit the QM characteristics. Therefore, it accommodates people who do not have the standard documentation to prove that they are capable of making those mortgage payments. If you do not fit into the conforming model but still have the credentials like sizeable assets or a big, if sporadic income, you can qualify for a non-QM.
The main difference between these two types lies in liability protection. In a QM, government agencies protect the lender against any type of lawsuit should you become unable to afford their mortgage payments and want to sue. A lender, in this case, is also safe against penalties should the borrower default. For non-QM, loans are available to borrowers, yet the lender is not provided with protection if sued by the borrower.
Qualified Mortgage Requirements and Its Categories
Understanding what makes a qualified mortgage will help you determine if you fall into the non-qualified loan category. For Qualified Mortgages, the following guidelines apply:
- Debt ratio cannot exceed 43% no matter the type of loan (FHA, VA, conventional)
- Points and/or fees should not exceed 3% of the loan amount
- The loan cannot be interest only, have negative amortization, or any other risky features
- Verification of income is required (no stated income or asset verification only)
- Loan term must not exceed 30 years
QMs can also be broken down further into:
General QM Loans – these loans need to be underwritten using a fully-amortized payment. The maximum interest rate is permitted in the first five years after the first payment date. Borrower’s monthly debt-to-income (DTI) should not go beyond 43 percent and should be properly verified by a lender.
Temporary QM Loans – must meet all the requirements of a General QM Loan and should also be eligible for purchase or guarantee by Fannie Mae, Freddie Mac or federal agencies like the Federal Housing Administration (FHA). However, it is not subject to the DTI conditions of a General QM Loan. This loan category is expected to expire no later than January 10, 2021, or earlier once the QM rules of specific federal agencies take over or when government-sponsored enterprises (GSEs) exit federal conservatorship.
Small Creditor QM Loans – these are loans made by creditors that are held in their own portfolios. They also share similar requirements as General QM loans but do not require a specific loan limit.
The Qualified Mortgage guidelines make it difficult for certain borrowers to obtain a loan. If you have a credit score on the lower end of the spectrum, the lender needs to charge higher fees in order to make up for the risk. If you cannot verify your income because you are self-employed, but have plenty of assets to afford the loan or your debt ratio is higher than 43%, you may not qualify for a QM loan altogether.
If you fall short of QM guidelines this does not mean you are automatically unable to get a loan or that you are destined to have a high-interest rate and/or fees. You’ll just have to look into non-qualified loan options.
Nonqualified Loan Scenarios
There is a perceived demand for Nonqualified Mortgages. Deutsche Bank Securities placed non-QM origination volume at around $50 billion. The market for this type of loan typically includes individuals experiencing one or more of these unique circumstances:
- Self-employed for less than 2 years
- Self-employed and not showing a great amount of income on tax returns
- High debt ratio yet plenty of reserves to make up for the debt ratio
- Blemished credit due to unforeseen circumstances during the downfall of the economy
Immediately following the housing crisis, loans for borrowers in any of these predicaments was hard to find, but they are more readily available today by a variety of lenders.
Ability to Repay Rule
It needs to be stressed that a non-qualified loan does not mean you cannot repay the loan. The lender is still going to do due diligence in evaluating your financial situation. They will not provide loans to borrowers that do not demonstrate the ability to repay the loan. The Ability to Repay Rule put into place by the Dodd-Frank Act, requires lenders to ensure that borrowers can afford the loan. This means:
- Verifying income and asset
- Verifying employment
- Accurately calculating the debt to income ratio
- Evaluating credit history
Lenders are able to charge higher interest rates and/or fees for loans that pose a slightly higher risk than a Qualified Mortgage would allow, yet they must make sure the payment is affordable. What this means is the days of stated income and stated asset loans are gone. Lenders need solid proof that the borrower can afford the loan with slightly higher rates and/or fees with ease. They are not supposed to put borrowers in a difficult financial situation.