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A qualified mortgage is a home loan that meets federal guidelines aimed at preventing lenders from issuing loans that borrowers can't afford to repay. These guidelines were created in the wake of the 2008 financial crisis and are designed to be less risky for borrowers and lenders alike.
Qualified Mortgage Requirements
The Consumer Financial Protection Bureau (CFPB) lists four general requirements a loan must meet to be considered a qualified mortgage.
1. Ability-to-Repay Rule
The lender must make a good faith effort to ensure borrowers can make monthly mortgage payments by documenting income, assets, employment, credit history and monthly expenses. Lenders must also consider the borrower's debt-to-income ratio (DTI) or residual income in this calculation.
This rule excludes mortgages with low initial interest rates (known as teaser rates) that rise dramatically at the end of an introductory period.
2. Restrictions on Risky Loan Features
Certain other types of mortgage loans that can put borrowers at risk are also excluded from qualified mortgage status, including:
- Loans that include reduced interest-only payments for a portion of the repayment period, during which the borrower accumulates no equity in the property.
- Negative-amortization loans, under which the principal owed on the loan increases over the course of the repayment term.
- Loans that call for a large final payment (often called a balloon payment) at the end of the repayment term.
- Mortgages with repayment terms longer than 30 years.
3. Pricing Limits
The annual percentage rate (APR) on a qualified mortgage cannot exceed a certain threshold, which can vary based on the type of loan and its size. For most loans, the APR must exceed the average prime offer rate (APOR) for a comparable transaction by less than 2.25 percentage points as of the date the rate is set.
There are higher thresholds for loans with smaller loan amounts, for certain manufactured housing loans and subordinate-lien transactions. There's also a special calculation for adjustable-rate mortgages for purposes of comparing the APR to the APOR.
4. Limits on Points and Fees
Lenders are prohibited from charging excess upfront points (upfront payments characterized as percentage points of the total loan amount) and fees. The maximum amount they can charge depends on the loan amount:
| Total Loan Amount | Maximum Points and Fees |
|---|---|
| $100,000 or more | 3% of the total loan amount |
| $60,000 to $99,999.99 | $3,000 |
| $20,000 to $59,999.99 | 5% of the total loan amount |
| $12,500 to $19,999.99 | $1,000 |
| Less than $12,500 | 8% of the total loan amount |
Source: Consumer Financial Protection Bureau
Federal Housing Administration (FHA) insurance premiums and certain other types of fees are not included in point and fee limits.
Types of Qualified Mortgages
When the CFPB created guidelines for qualified mortgage loans, it made provisions for certain special-case exemptions. As a result, there are currently two subcategories of loans that can be considered qualified mortgages.
General-Definition Qualified Mortgages
These mortgage loans meet all four of the requirements listed above. As such, they don't need an exemption from the rules.
Small-Creditor Qualified Mortgages
Smaller mortgage lenders, such as community banks and credit unions, that meet certain asset and origination requirements can call their loans qualified mortgages if they keep the loans in their own portfolios, meaning they can't sell the loan to a government-sponsored enterprise or another secondary buyer.
They must also consider and verify each borrower's DTI or residual income as part of their lending decisions, though there's no specific DTI limit.
Pros and Cons of Qualified Mortgages
If you're planning to take out a mortgage to buy a house, it's important to understand both the benefits and drawbacks of a qualified mortgage to ensure you get the right one for you. Here's what to keep in mind.
Pros
- Helps ensure affordability: While your situation can change after you get approved, qualified mortgages have strict guidelines to ensure that you can afford your monthly payments based on your financial situation when you apply for the loan.
- Helps you avoid risky features: While certain features of non-qualified mortgages can work for some borrowers, most homeowners benefit from a safer mortgage product that won't potentially result in a growing loan balance, a costly balloon payment or other risky features.
- Widely available: Qualified mortgages are far more common than non-qualified mortgages, making them easy to find.
Cons
- Less flexibility: If it makes sense in your situation to opt for interest-only payments, a balloon payment or a 40-year term, you won't get that option with a qualified mortgage loan.
- Harder to get: Qualified mortgage loans have more strict underwriting guidelines and don't offer as much leniency for self-employed borrowers, real estate investors and people with lower credit scores.
- Qualifying criteria are complex: Some of the general guidelines for qualified mortgages are clear, but others, particularly when it comes to pricing limits and small creditors, can be difficult to follow.
Qualified Mortgage vs. Non-Qualified Mortgage
Non-qualified mortgages can be riskier for borrowers because they don't meet all of the same requirements as qualified mortgages. Not all of them necessarily have risky features like balloon payments and interest-only periods, but they typically come with higher interest rates.
That said, a non-qualified mortgage loan can be worth considering for real estate investors and borrowers who may find it difficult to obtain a qualified mortgage due to a low credit score, higher level of debt or fluctuating self-employment income.
If you don't meet the requirements for a qualified mortgage, you could apply for a non-qualified loan, then refinance to a qualified mortgage later once you meet the criteria.
What Credit Score Do I Need to Get a Mortgage?
Credit score requirements for a mortgage loan can vary by loan type and lender, so it's important to shop around and compare your options before you apply.
With conventional loans, for instance, you can typically expect a lender to require a minimum credit score of 620. FHA loans can go as low as 580 or even 500 with a 10% down payment. Some specialized loans, such as jumbo loans, may have higher credit score requirements. Check with a mortgage broker or loan officer to learn more about your options.
Review Your Credit Before Applying for a Mortgage Loan
To know where you stand before you apply for a mortgage, it's a good idea to check your credit score and review your credit reports from all three national credit bureaus (Experian, TransUnion and Equifax), which you can do for free at AnnualCreditReport.com. You can also view your Experian credit report for free anytime.
If your score isn't as strong as you might hope, consider taking some steps to spruce up your credit before you apply for your mortgage.