Home loans carry certain inherent risks for borrowers and lenders. However, the 2008 financial crisis showed some mortgage risks could pose a threat to the entire economy. As a way to make home lending safer for consumers and everyone else involved, Congress instituted a new form of mortgage known as a qualified mortgage. Here’s a closer look at how these mortgages work and what protections they provide:
Per the Consumer Financial Protection Bureau, lenders must meet strict requirements for their loans to be classified as qualified mortgages — thus reducing the risk borrowers might default. First, the loan can’t incorporate dangerous elements that could make it harder for a borrower to pay back the loan. Features that are typically prohibited include loan terms longer than 30 years, balloon payments that start out low but rise dramatically at the end of the loan term, and negative amortization (which allows the loan principal to increase).
Second, the cost of a qualified mortgage loan and its related fees are subject to certain limits. According to a new rule issued by the CFPB, the annual percentage rate charged by the lender must exceed the annual prime offer rate for a similar loan by less than 2.25%. However, lenders are allowed to charge somewhat higher interest rates for loans under $110,260 or for loans involving manufactured homes. Upfront points and fees are restricted, too. According to Anna Baluch of The Balance, these aren’t allowed to exceed 3% of a loan’s value, although higher fees are allowed for mortgages under $100,000.
Qualified mortgages also come with safeguards for borrower eligibility. When you apply for a home loan, the lender is required to verify and take into consideration your monthly income, assets, debt-to-income ratio, and overall ability to repay the loan before moving forward. These precautions can protect you from taking on a larger mortgage than you can handle, helping to prevent missed payments and eventual foreclosure.
What about non-qualified mortgages?
Qualified mortgages provide more protections for borrowers, lenders, and the financial system, but in some cases, a non-qualified mortgage might make more sense in your quest to purchase a home. Non-qualified mortgages aren’t subject to the same requirements, which means that more potential homeowners are eligible. Baluch points out if you’re self-employed and have irregular monthly income, or if you’re saddled with poor credit or recovering from bankruptcy, you might be able to get a non-qualified mortgage even when a qualified one is out of reach. However, if you do opt for a non-qualified mortgage, it’s important to understand all of its terms. Risky elements and higher interest rates aren’t prohibited like they are in qualified mortgages.
If you’re planning to purchase a home soon, it’s worth familiarizing yourself with the requirements of a qualified mortgage. If you’re eligible for one, you can enjoy greater peace of mind about your ability to repay what you owe. And if you’re not eligible, you’ll have a better grasp on the additional risks that could accompany a non-qualified mortgage.