It's a question almost everyone is asking: "Should I refinance my mortgage?" If so, what's the best way to pay for my mortgage refinance

It's a question almost everyone is asking: "Should I refinance my mortgage?" If so, what's the best way to pay for my mortgage refinance

What is a Qualified Mortgage?

A Qualified Mortgage (QM) is a defined class of mortgages that meet certain borrower and lender standards outlined in the Dodd-Frank regulation. These are made in conjunction with an Ability-to-Repay (ATR) standard that requires lenders to evaluate and ensure that a borrower will be able to meet his or her mortgage obligations.

ATR requires that a lender make a good-faith effort to determine that you have the ability to repay your mortgage before you take it out. If a lender makes a Qualified Mortgage available to you it means the lender met certain requirements and it’s assumed that the lender followed the ability-to-repay rule.

The Ability-to-Repay rule outlines eight criteria the lender must use to determine if you can or cannot make mortgage payments. For each application, the lender must review:

  • Your current or reasonably expected assets or income
  • Your current employment status
  • The expected monthly payment on the mortgage
  • Any monthly payments on any other mortgages, such as a piggybacked second lien
  • Any monthly payment for mortgage-related obligations (i.e. property taxes, PMI, HOA fees, required insurance)
  • Your current debt obligations, including any alimony and child support requirements
  • Your monthly Debt-to-Income (DTI) ratio, and residual income available to satisfy normal living expenses
  • Your credit history

If a lender fails to comply with ATR and the borrower can prove this in court, the lender could be liable for up to 3 years of the loan's interest costs, any charges and fees the borrower paid and the borrower's legal fees.

If you're wondering why lenders have been sticklers for documentation regarding your income and credit, ATR is the reason.

OK, you're passed the ATR standard and can be offered a Qualified Mortgage. To be considered a QM, the loan being offered also needs to meet certain standards. In general, qualified mortgages don't allow for certain "risky" features or loan terms and are thought to be more stable and "safe" for borrowers.

The Qualified Mortgage definition bans loans with:

An "interest-only" payment period, when you pay only the interest without paying down the principal, which is the amount of money you borrowed. Interest-only payment plans were mostly applied to hybrid ARMs, but were also found on some fixed-rate mortgages for a time, too. These are still available in the market to some borrowers but they don't qualify as a QM.

"Negative amortization", a process where you aren't making a large enough required payment to cover all of the interest due on the loan. Deferred interest is added back onto the loan amount, causing your loan's principal to increase over time, even though you are making payments. These payment structures were offered as a component on so-called "Option ARMs".

Mortgages with "balloon" payments, which require the full repayment of the loan after just a few years' time. A typical balloon mortgage might see you make payments as though the loan has a 30-year repayment term, but the remaining outstanding balance of the loan becomes fully due and payable at the end of the seventh year. These were attractive to some borrowers as they often offered interest rates lower than comparable traditional 30-year loans. Balloon mortgages are still allowed to be made by small lenders with assets under $2 billion or who make fewer than 500 residential mortgages per year.

"No-documentation" loans. At their face, these of course run afoul of ATR rules. For a time, these were prevalent in both prime and subprime mortgage markets. While true no-doc loans are virtually non-existent, non-QM lenders do offer "alt-doc" and "lite-doc" mortgages to some borrowers, but they don't qualify as a QM.

Loan terms that are longer than 30 years. At one point in the last housing boom, with home prices and mortgage rates rising, 40-year mortgages came back onto the mortgage scene as they helped to keep payments low. Later, in fact, these were often used in loan modification programs such as HAMP. With a fixed interest rate, borrowers liked these, but the long-term interest costs make these a very costly option. While they may be available at times in the market, they can't be QMs.

Points and fees that exceed 3% of the loan amount. One component of the subprime mortgage market was loans with high points and fees. Often buried back into the loan amount, these steep costs in turn stripped equity from borrowers; when combined with loans that needed to be refinanced fairly frequently, they contributed to the underwater mortgage crisis when home prices declined. Certain fees, such as an upfront FHA mortgage insurance premium aren't included in this tally. These point-and-fee threshold limits depend on the size of your loan, and are indexed for inflation and change each year.

2020 Points and Fees Threshold for QMs

Effective January 1, 2020 a covered transaction is not a qualified mortgage under the ATR/QM Rule unless the transaction’s total points and fees do not exceed:

• 3 percent of the total loan amount for a loan amount greater than or equal to $109,898;
• $3,297 for a loan amount greater than or equal to $65,939 but less than $108,898;
• 5 percent of the total loan amount for loans greater than or equal to $21,980 but less than $65,939;
• $1,099 for a loan amount greater than or equal to $13,737 but less than $21,980; and
• 8 percent of the total loan amount for loans less than $13,737.

Also effective January 1, 2020, a transaction is determined to be a high-cost mortgage if its points and fees exceed the following thresholds:
• 5 percent of the total loan amount for a loan amount greater than or equal to $21,980; and
• 8 percent of the total loan amount or $1,099 (whichever is less) for a loan amount less than $21,980.

Borrower Debt-to-Income (DTI) ratios greater than 43%. However, Dodd-Frank allowed for two QM standards when it was implemented, allowing a "temporary" exemption (sometimes called the "GSE patch") from the 43% DTI ratio for loans that can be sold to Fannie Mae and Freddie Mac (the GSEs). To meet the "temporary" QM definition, loans must be underwritten using the required guidelines of the GSEs, including any relevant DTI guidelines. However, and at least until the GSEs exits federal conservatorship or January 10, 2021 (whichever comes first), these loans do not have to meet the 43 percent debt-to-income ratio threshold that applies to General QM loans.

After employing a 45% DTI standard for a couple of years and having studied the potential for loss, Fannie and Freddie are buying and backing loans with DTIs as high as 50% in some circumstances. These often have risk-offsetting characteristic, such as higher credit scores or deeper reserves. In additional to these certain restrictions, PMI costs for loans in excess of 45% DTI are higher.

OK, so you and the lender meet ATR and QM requirements. What does this actually do for both of you? Theoretically, you get a mortgage for which you have been fully vetted, and so are less likely to default in the future.

For the lender, meeting ATR and QM standards offers some specific legal protection; QM loans that meet certain pricing limits provide lenders with a "safe harbor" (called a "conclusive presumption") provision that limits a borrower's ability to sue on grounds that the lender didn't properly measure his or her ability to repay the loan. Non-QM loans and even certain "high cost" QM loans don't afford this protection to the lender, where a "rebuttable presumption" standard is used, giving borrowers somewhat stronger legal rights that the lender didn't properly employ ATR standards before making the mortgage loan.

For QM loans, the standard is applied using a federal formula based on the Average Prime Offered Rate (APOR) for a mortgage, plus 1.5 percentage points. Below this threshold, a loan is considered to provide the lender a "safe harbor". Above it, it is considered a "high cost" mortgage and is subject to the "rebuttable presumption" above. This "higher-priced" standard also applies to closed-end second mortgages, too, but the formula is APOR + 3.5 percentage points.

Can I get a non-QM mortgage?

Sure. In fact, non-QM lending is a fast-growing segment of the mortgage market. These include certain kinds of jumbo mortgages, hybrid ARMs with interest-only payments, loans with different borrower documentation to prove income, such as bank statements instead of classic W-2 forms, portfolio loans not sold to the GSEs with DTIs above 43% and other such characteristics. Given sizable losses on them, we probably won't again see loans with negative amortization, but never say never. These kinds of loans flourished in the 1980s, only to flame out and disappear from the mortgage menu for 20+ years before returning. Mortgage market makers continue to look to innovate, and the non-QM space is where new and novel mortgage products will come from in the years ahead.

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