Buying a home is one of the biggest financial decisions you’ll make in your lifetime, and it can be difficult to choose a mortgage amid the swirl of terminology and numbers. In addition to understanding the interest rate, points and years of repayment, changing any one of these variables results in your paying more or less each month — and possibly much more or less over the life of the loan.
Recent government regulations aimed at protecting both consumers and lenders from the misunderstandings that can arise from all this data, help make the entire process more transparent. Known as Qualified Mortgage, these loans require lenders to get more information from potential buyers and do more paperwork, but in the end, it gives lenders and buyers a better understanding of the buyers ability to repay the type of mortgage they want.
How Does a Qualified Mortgage Work?
Qualified Mortgages were implemented in 2014 by the Consumer Financial Protection Bureau as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It aims to make sure lenders aren’t giving loans to consumers that will be difficult to pay back. These rules were a direct result of the financial crisis of 2008 that left many homeowners underwater on their mortgages and unable to pay for their homes, which in turn resulted in record numbers of foreclosures during the Great Recession.
The rules about Qualified Mortgages include the following:
- No loans may be longer than a 30-year term.
- Points and fees must equal less than 3% of the total loan amount.
- No interest-only payback periods.
- No negative amortization, so the amount you owe in principal can never rise.
- No balloon payments, which are extra-large payments near the end of the loan’s term.
- A limit to how much of your income can go toward your debt, meaning that you can’t be approved for a loan that takes up too much of your income.
- Banks must take into account your ability to pay back the loan before approving the amount to avoid predatory lending situations.
Choosing a Qualified Mortgage means that you can be confident that your lender is following these rules and that, barring any drastic changes in your income or life circumstances, you should be able to repay the mortgage on schedule. This will help you keep your home and avoid any damage to your credit score by defaulting on the loan.
How Your Credit Score Affects Your Qualified Mortgage
While these rules are helpful to homebuyers and offer a level of protection against predatory lending practices, the government does not regulate the interest rates charged by banks. Your rate is largely determined by your credit score, which lenders use as a measure of risk. A high credit score means that, based on your payment history, you are likely to make your mortgage payments on time and in full. Likewise, late payments or defaulting on a loan will lower your score and indicate to a bank that you are not as good a risk for them — and they’ll likely charge you higher interest rates as a protection for their investment in your house.
It’s in your best interest to know your credit score and to check your credit report for any errors that could make a bank want to charge you higher interest rates. The Fair Credit Reporting Act (FCRA) requires Equifax, Experian and TransUnion — the big three credit score reporting companies — to provide a free copy of your credit report once a year. You can access these on AnnualCreditReport.com.
You can also sign up for a free credit monitoring service, which will alert you to any changes in your credit report so you can nip any errors in the bud. Mistakes happen, but they can be costly when it comes time to apply for a loan or mortgage. You also can get two free credit scores from Credit.com. This service also provides a helpful explanation and breakdown of your score that allows you to plan for improvements that will build your credit.
Understanding Your Borrowing Rights
Understanding your rights as a borrower and knowing your credit score are crucial tools for getting a great rate on your mortgage. Being able to borrow at an affordable rate will open the doors to your dream home, so all you have to do is move in.