Regulation Z defines a general qualified mortgage (QM) with a short list of conditions. A loan that fails any of them, and doesn't fit one of the other QM categories, is a non-QM loan. Each item is a clear yes-or-no test, which makes the list easy to study for the SAFE MLO Test.
1. Risky payment features
A QM must have regular periodic payments that are substantially equal (allowing for rate changes on an adjustable-rate or step-rate loan) and that do not:
- increase the principal balance: no negative amortization
- allow the borrower to defer repaying principal: no interest-only period
- result in a balloon payment
A loan with any of these features is non-QM under the general definition. The one notable exception: certain loans made by small creditors can include a balloon payment and still qualify under a separate small-creditor QM category.
Related: What to Expect on the NMLS SAFE MLO Exam
2. A term longer than 30 years
A QM's loan term may not exceed 30 years. A 40-year mortgage is non-QM.
3. Points and fees above the cap
Total points and fees on a QM may not exceed 3 percent of the total loan amount for larger loans. Smaller loans have higher caps, set as dollar amounts or percentages, and the loan-size thresholds are adjusted for inflation each year. Exceed the cap and the loan is non-QM.
4. Underwriting at the right payment
For a QM, the creditor must underwrite using the maximum interest rate that can apply during the first five years after the first payment is due, with a fully amortizing payment. This stops an adjustable-rate loan from qualifying on a low teaser payment.
5. Considering and verifying income and debts
The creditor must consider income or assets, debts, alimony, child support and the debt-to-income ratio or residual income, and verify them using reasonably reliable third-party records.
6. Pricing
A general QM's annual percentage rate may not exceed the average prime offer rate for a comparable loan by more than a set margin. The margins differ by loan size and lien position, and the loan-size thresholds are adjusted annually.
A consequence worth knowing: prepayment penalties
Under Regulation Z, a covered mortgage may include a prepayment penalty only if the loan has an APR that can't increase, is a qualified mortgage, and is not a higher-priced mortgage loan, and only if the penalty is otherwise permitted by law. Even then, the penalty can't apply after three years and is capped at 2 percent of the balance prepaid in the first two years and 1 percent in the third, and the creditor must offer an alternative loan without one. A non-QM loan can't carry a prepayment penalty under this rule.
How to remember it
Think of QM as the plain-vanilla loan: fully amortizing, 30 years or less, reasonable fees, reasonable price, carefully underwritten. Add a risky feature, a long term, high fees or high pricing, and you are in non-QM territory.