QM and QRM Rules for Mortgages: Let the Confusion Begin

The rules regarding the qualified mortgage and qualified residential mortgage have yet to be finalized. But that hasn’t stopped a flurry of discussion and speculation from taking place. Here, we will attempt to set the record straight on these forthcoming changes.

Leave it to the government. In an effort to stabilize the housing finance industry and prevent another mortgage meltdown, the federal government has left many consumers baffled. Worst of all, the sources of all the confusion (QM and QRM guidelines) haven’t even been finalized yet. As a result, the mere mention of QM or QRM conjures confusion, speculation and uncertainty.

Earlier this week, I received an email from a concerned home buyer. She was in a rush to buy a home, because her real estate agent told her there would soon be a mandatory down-payment requirement of 20% for all home loans. This is not true at all. At first, I thought it was an isolated incident, a single real estate agent who had his facts mixed up. But then I did some Googling, and I found the source of the confusion — time and time again. There is an abundance of misinformation online, regarding the implementation of QM and QRM rules.

Here’s the truth of the matter. There will eventually be a qualified mortgage (QM) and a qualified residential mortgage (QRM). They have similar names and origins but are not the same thing. They will have a profound impact on the lending industry by outlining the requirements for home loans. They have been postponed until 2013. And frankly, we’re not even sure what kinds of provisions and requirements they will include. It’s no wonder everyone is so confused.

Setting the Record Straight: QM and QRM

The qualified mortgage and the similarly named qualified residential mortgage both have their roots in the Dodd-Frank Wall Street Reform and Consumer Protection Act. This legislation is designed to prevent certain high-risk activities within the financial sector, the kinds of activities that fueled our housing collapse and economic meltdown. In the area of mortgages, the Dodd-Frank Act aims to reduce the number of borrower defaults and foreclosures. It seeks to do this by imposing certain guidelines on the lending industry, and giving lenders strong incentives to follow those guidelines.

The final definitions of QM and QRM are forthcoming, and have been for some time. In fact, the Consumer Financial Protection Bureau recently delayed such actions by implementing another “public comment” period. There is little chance of these regulations being finalized in 2012. They likely won’t take effect until January 2013 or later (conveniently after the election season).

QM and QRM at a Glance

Qualified Mortgage (QM): The QM is defined under Section 1411 of the Dodd-Frank Act, though the precise definition and criteria are still pending. It has been referred to as the “ability to repay” rule for mortgage loans. Basically, lenders will be required to obtain and verify financial documents to ensure a borrower has a “reasonable ability to repay the loan.” There will also be restrictions on interest-only loans, prepayment penalties,  and negative amortization. The requirements set forth by the QM rule will apply to all residential home loans, once the regulations are finalized and published. It’s worth noting that many of these income-verification procedures are already being used by lenders.

Qualified Residential Mortgage (QRM): The exact definition of the QRM is also pending. Here, the focus is on mortgage loans that will be securitized and sold by the lender. The Dodd-Frank Act requires lenders to retain at least 5% of their securitized mortgages. This is known as a risk-retention rule. Most lenders prefer to sell their loans in order to minimize their long-term risk. If a lender makes a loan that meets the criteria set forth under the QRM rules, that loan is exempt from the risk-retention rules. This is all spelled out under Section 941 of the Dodd-Frank Act, entitled “Regulation of Credit Risk Retention” and excerpted here. Section 941 calls on the federal banking agencies, HUD, and FHFA to “jointly define the term Qualified Residential Mortgage.” They have yet to finalize this definition, and it probably won’t be defined until 2013.

Here is a snapshot of the portions of Dodd-Frank that explain the qualified residential mortgage:

QRM text
An excerpt from the “Credit Risk Retention” section of the Dodd-Frank Act

Adding to the confusion is this: The Dodd-Frank Act goes on to state that the agencies that define the QRM “shall define that term to be no broader than the definition ‘qualified mortgage’ as the term is defined under section 129C(c)(2) of the Truth in Lending Act.” So it seems the final definitions of QM and QRM may be very similar, if not identical. Perhaps it is more accurate to describe them not as two separate sets of rules, but as two separate uses for the same rules.

The qualified mortgage will likely become the minimum standard applied to all home loans in the U.S. It will establish the basic criteria for approval. The qualified residential mortgage will be used to determine which loans are subject to risk-retention rules, and which ones are not. But the criteria used for both the QM and QRM could end up being the same, or at least very similar. It’s just too soon to tell.

Standards On Top of Standards?

Many in the financial industry fear these regulations will spell trouble for a housing market that is still struggling. The new rules could make it even harder for buyers to qualify for financing, the argument goes.

“We’re piling tighter standards on top of already tight credit standards,” said Laurie Goodman of Amherst Securities Group LP. “And because you have so many different entities responsible for making these rules no one is really looking at the interaction.”

The Center for Responsible Lending, a nonprofit group that protects consumers from predatory lending, shares some of these concerns. In a reported entitled “Balancing Risk and Access: Underwriting Standards and Qualified Residential Mortgages,” the CRL wrote the following:

“By setting overly stringent regulatory thresholds for loan-to-value (LTV) or downpayment requirements, debt-to-income (DTI) ratios, and borrower credit scores, there is a risk that QRMs will disproportionately exclude lower-income households…”

It’s true there have been proposals to this effect. Some regulators have suggested placing additional rules on the QRM, above and beyond what is required by the QM definition. But they are only proposals. There have been a variety of proposals, counter-proposals, and water-cooler conversations about what should go into the QRM. We won’t know for several more months what the final rules look like. I don’t expect to hear much until after the upcoming presidential election.

QualifiedResidentialMortgage.org – Our Small Part in All of This

Government websites have a habit of shifting content around. This makes it hard to find straight answers to your questions. Have you tried researching FHA loan guidelines lately, using the HUD website? You get bounced around from one “portal” to the next. It’s a wild goose chase.

With this in mind, we have decided to launch a new website entirely dedicated to the subject of QRM regulations and criteria.

This website is designed to alleviate some of the confusion surrounding these forthcoming regulations. It will provide a standardized definition of the QRM, as soon as those standards are finalized. It will always be in the same place, under the same domain name. It will be updated on a regular basis as new information becomes available. It is an ad-free, not-for-profit learning center.

Though the website is currently in beta mode, it already provides a wealth of information on this topic. We hope you find it useful.