If you’re shopping for a home loan, you may hear references to both qualified and nonqualified mortgages. What are these loans, and how do they differ?
Qualified vs. nonqualified
A qualified mortgage meets certain standards designed to protect borrowers by increasing the likelihood they will be able to repay their home loans. These rules were put in place by the federal Consumer Financial Protection Bureau (CFPB), which the government created in the wake of the 2008 mortgage market crash to protect consumers from risky lending practices. Qualified mortgages cannot:
- Entail risky repayment features such as interest-only payments, balloon payments, unusually low payments in the loan’s early years, or negative amortization.
- Be granted to borrowers whose debt-to-income (DTI) ratio exceeds 43 to 57 percent.
- Offer repayment terms that exceed 30 years.
- Involve unusually high upfront fees.
With a qualified mortgage, lenders must follow “ability to repay” rules that require them to document borrowers’ employment, income, savings and investments, and credit history. The CFPB imposes these requirements to curb lending practices that could harm borrowers and lead to another mortgage market meltdown.
Borrowers who have difficulty getting a qualified loan may be able to obtain an nonqualified loan, which does not meet the standards discussed above. Nonqualified mortgages offer a means to get a home loan to borrowers with variable income – freelancers, for example, or those who are paid commissions – as well as people with lower credit scores or debt loads that exceed the DTI that qualified loans require.
The underwriters reviewing applicants for nonqualified loans review the borrower’s financial information to assess their ability to repay the loan, but the requirements will be more relaxed. Because they are riskier to the lender, nonqualified mortgages may require larger down payments and charge a higher interest rate.
Related – What’s the Difference Between a Conforming and a Conventional Mortgage?
