Qualified mortgages are becoming a household name. Mitt Romney railed about them during his first debate with President Obama. The National Association of Realtors gripes about them on a regular basis. They’ve appeared in hundreds of news stories, from the Wall Street Journal to the Huffington Post. Oddly enough, they don’t exist yet.
There isn’t a finalized definition of ‘qualified mortgage’ — not yet anyway. It’s forthcoming. But that hasn’t stopped a legion of bloggers and journalists from writing about it. This has led to a mountain of misinformation, with new rumors added to the pile every week.
In the interest of dispelling some of these rumors, we have created a fact sheet about the current (and future) state of the now-infamous qualified mortgage.
Qualified Mortgage Rules at a Glance
Let’s start with a graphical introduction of the terminology in use here. Here’s a high-level overview of the qualified mortgage (QM) and the qualified residential mortgage (QRM).
Ten Things You Should Know About QM Rules
The forthcoming QM rules will not dismantle the mortgage industry, as some would have you believe. Home financing won’t be limited to the rich. And there probably won’t be a 20% down-payment requirement. These are just a few of the rumors swirling around. Here are the facts on the qualified mortgage, as of October 2012:
1. It comes from the Dodd-Frank Act.
The term ‘qualified mortgage’ comes from the Dodd-Frank Act (full name, the Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R.4173). This act was signed into law in July 2010. It represents a broad attempt to reform the financial industry in the United States. Among other things, the Dodd-Frank Act provides a list of criteria for what can be labeled a qualified mortgage.
2. It is meant to reduce risky mortgage loans.
The qualified mortgage rules are designed to reduce the number of high-risk home loans originated in the United States. For instance, the rules will limit the use of negative-amortization loans, wherein the principal amount borrowed actually grows over time. The legislation will also provide specific requirements for the borrower’s ability to repay the loan (see item #4 below).
3. It will become the ‘gold standard’ for mortgage loans.
The QM rules will have a broad effect on the mortgage industry, when they are finalized and implemented. They will essentially set the bar for minimum qualifications on home loans.
Lenders will abide by these rules for most of the loans they originate, because it gives them special legal protections (such as a ‘safe harbor’ from borrower lawsuits). So you can expect it to become the gold standard in mortgage lending.
“QM will, in my mind, largely define the market,” said Michael J. Heid, president of Wells Fargo Home Mortgage (source).
4. It focuses on the borrower’s ability to repay.
The ‘ability to pay’ concept lies at the center of the qualified mortgage rules. In short, lenders must take reasonable steps to ensure that borrowers have the financial means to repay their loans. Translation: No more ‘low-documentation’ or ‘no-documentation’ loans, also known as stated-income or ‘liar loans.’
As stated in the legislation, lenders must verify and document “the income and financial resources relied upon to qualify the obligors on the loan.”
The lender must also assess the borrower’s debt-to-income (DTI) ratio, to ensure the current debt load won’t interfere with the borrower’s ability to repay the loan. Specific DTI requirements are still forthcoming. See item #10 below.
5. It will limit the use of balloon loans and interest-only mortgages.
We touched on this earlier. The qualified mortgage rule will, in most cases, prevent borrowers from deferring the repayment of principal (and thereby creating a negative-amortization, or growing principal, situation). The principal balance cannot increase as long as the borrower makes regularly scheduled payments.
The rules also limit the use of balloon payments, defined as “a scheduled payment that is more than twice as large as the average of earlier scheduled payments.” These and other types of high-risk mortgages have been widely cited as a contributing factor in the housing collapse.
6. It has led to rumors of a 20% down-payment requirement.
Nothing gets the rumor mill cranking like an information void. Unfortunately, that’s what we are seeing with the qualified mortgage rules. They have been proposed but not finalized, giving rise to all sorts of speculation. The idea of a mandatory 20% down payment is a good example. We attempted to control the spread of this rumor back in January, to no avail.
There actually was a proposal for a 20% down-payment requirement across the board. But it spawned a backlash of opposition from a variety of interests. Everyone from labor unions to real estate agents denounced it. The proposal is still out there, but there is slim chance of it becoming law. The banking industry is too strong of a lobby, and it has too many friends on this particular issue.
For an excellent update on the 20-percent proposal, see Kenneth Harney’s column in the Washington Post.
7. It will likely protect mortgage lenders from consumer lawsuits.
A key provision of the qualified mortgage is that it will (likely) extend legal protection to lenders. The idea is this: If a lender makes a loan that meets the criteria set forth under the QM rules, that lender will be protected from any legal action on the borrower’s part. Call it an escape clause, and you’d be close to the mark.
If passed into law, this rule would give lenders a safe harbor from certain types of lawsuits. It would essentially require judges to “rule in the lenders’ favor if consumers contest foreclosures,” according to the Wall Street Journal.
The full extent of the coverage has yet to be defined. You can expect to hear more about it between now and January 2013.
8. It’s not the same as a qualified residential mortgage.
Many bloggers, and even a few journalists, have used the terms ‘qualified mortgage’ and ‘qualified residential mortgage’ interchangeably. They do sound the same, after all. But they are two different things. The former has to do with underwriting standards, while the latter has more to do with risk retention. Think of the qualified residential mortgage (QRM) as an extension of the qualified mortgage (QM).
Borrowers should be most concerned with the definition of QM, since it will affect their ability to qualify for a home loan.
The QRM criteria have less to do with consumers and more to do with Wall Street. The QRM rules determine which loans are subject to the 5% risk-retention requirement imposed by Dodd-Frank, and which ones are exempt from that requirement. In short, lenders can sell 100% of loans that meet the definition of a qualified residential mortgage.
9. It only exists on paper right now.
None of these rules have been implemented yet. They only exist in skeleton form, within the text of the Dodd-Frank Act. The meat hasn’t been added. The Consumer Financial Protection Bureau (CFPB) has been receiving public comments, discussing the legislation with financial groups and government agencies, and otherwise getting their ducks in a row.
10. Expect to see the finalized rules by January 2013.
According to the CFPB: “The CFPB expects to issue the final rule before the end of 2012. The rule is required under the Dodd-Frank Act by January 2013.” In the meantime, you can expect a continued slurry of rumors, complaints and speculation.