Conforming Loans and Qualified Mortgage Loans
Fannie Mae and Freddie Mac are the nicknames bestowed upon two government-sponsored entities - the Federal
Association and the Federal Home Loan Mortgage Corporation. These corporations have an active role in providing
financial security to
mortgage lenders and banks by purchasing certain mortgage loans from them. There are limits on the loan sizes the
Fannie and Freddie
accepts. These limits vary from county to county and are related to each county’s median home price.Fannie and
Freddie only purchase
loans that they deem as "conforming." There are various qualifications that a mortgage loan has to meet to
conform to the rules, but one
of the most important is the actual loan amount.
A conforming loan must follow the qualified mortgage rules that came into effect on January 2014.
The qualified mortgage rule, as defined by Consumer Financial Protection Bureau (CFPB), is designed to create safer loans by prohibiting or limiting certain high-risk products and features. Lenders that offer QM loans will receive legal protection against borrower lawsuits.
What Defines a Qualified Mortgage
The Consumer Financial Protection Bureau issued the definition of a Qualified Mortgage (QM) and basically contain the following key features:
No Excessive Upfront Points and FeesIn this context, ‘points and fees’ are additional costs charged by the lender during mortgage application, processing and closing. The QM rule puts a limit on these additional charges.
Generally speaking, the points and fees paid by the borrower must not exceed 3% of the total amount borrowed, if the loan is to be considered a qualified mortgage. Certain exceptions have been made for ‘bona fide discount points’ on prime loans.
No Toxic Loan FeaturesIn this context, a ‘toxic’ loan feature can refer to any high-risk feature that may have contributed to the mortgage and housing collapse of 2008. Such features are prohibited by the qualified mortgage rule, as defined by CFPB:
- No interest-only loans. These are mortgage products where the borrower defers the repayment of principal and pays only the interest, usually for a certain period of time.
- No negative-amortization loans. These are loans where the principal amount borrowed increases over time, even while monthly payments are being made. This often happens as the result of the interest-only payments mentioned above.
- No terms beyond 30 years. In order to meet the definition of a qualified mortgage, the loan must have a repayment term of 30 years or less.
- No balloon loans. In most cases, balloon loans will be prohibited by the QM rules. But some exceptions have been made. Smaller lenders in ‘rural or underserved areas’ may still make such loans. Definition: A balloon mortgage is one that has a larger-than-normal payment at the end of the repayment term.
Limits on Debt-to-Income RatiosIn general, the qualified mortgage will be granted to borrowers with debt-to-income / DTI ratios no higher than 43%. As the name implies, the debt-to-income ratio compares the amount of money a person earns each month (gross monthly income) to the amount he or she spends on recurring debt obligations.
This aspect of the QM rule is intended to prevent consumers from taking on mortgage loans they cannot realistically afford.
Lenders that generate QM-compliant mortgage loans will receive some degree of legal protection against borrower lawsuits. The level of protection they receive will depend on the type of loan they make. QM loans can be both Fixed and Adjustable Rate Mortgage (ARM) loans:
- 30 Year Fixed, Amortized over 30 Years
- 20 Year Fixed, Amortized over 20 Years
- 15 Year Fixed, Amortized over 15 Years
- 10 Year Fixed, Amortized over 10 Years
- 3 Year ARM, Amortized over 30 Years
- 5 Year ARM, Amortized over 30 Years
- 7 Year ARM, Amortized over 30 Years
- 10 Year ARM, Amortized over 30 Years