Two types of residential mortgage loans are common: fixed-rate mortgages, which have interest rates that do not change over the entire term of the loans, and adjustable-rate mortgages (ARM), which have interest rates that change periodically based on changes in a specified index. Residential mortgages also fall into several loosely defined categories: Prime mortgages are made to borrowers with strong credit histories and provide the most attractive interest rates and loan terms; Near-prime mortgages (also called Alt-A mortgages) generally serve borrowers whose credit histories are close to prime, but the loans have one or more higher-risk characteristics such as limited documentation of income or assets or higher loan-to-value ratios; Subprime mortgages are generally made to borrowers with blemished credit and feature higher interest rates and fees than prime loans; and Government-insured or -guaranteed mortgages primarily serve borrowers who may have difficulty qualifying for prime loans and feature interest rates similar to those for prime loans. HUD’s Federal Housing Administration (FHA), VA, and the Rural Housing Service operate major federal programs that insure or guarantee mortgages. The nonprime market segment (Alt-A and subprime) features a number of nontraditional products and characteristics: Hybrid ARM—interest rate is fixed during an initial period, then “resets” to an adjustable rate for the remaining term of the loan. Payment-option ARM—borrower has multiple payment options each month, including negative amortization (minimum payments lower than needed to cover any of the principal or all the accrued interest, which may increase the outstanding loan balance over time). Interest-only—borrower can pay just the interest on the loan for a specified period, usually the first 3-10 years, thereby deferring principal payments. Low and no documentation loans—require little or no verification of a borrower’s income or assets. High loan-to-value ratios—borrower would make a small down payment, causing the ratio of the loan amount to the home value to be relatively high. The higher the ratio when a loan is originated, the less equity borrowers will have in their homes. Prepayment penalties—borrower incurs a fee if he or she pays off the loan balance before it is due. Balloon payment loans—mortgages that do not fully amortize over the term of the loan, leaving a balance due at the end of the balloon period. Mortgages can fall into any one of several payment status categories: Current—borrower has met scheduled payments. Delinquent—borrower has missed one or more scheduled monthly payments. Default—borrower is 90 or more days delinquent. Foreclosure—borrower has been delinquent for more than 90 days and the lender has elected to initiate a legal process against the borrower that has several possible outcomes. Generally, the borrower loses the property because it is sold to repay the outstanding debt or is repossessed by the lender. Prepaid—borrower has paid the entire loan balance before it is due. Prepayment often occurs as a result of the borrower selling the home or refinancing. After the loan has been made, originating lenders can retain their loans in portfolio or sell them to investors on the secondary market, either as whole loans to other financial institutions or (directly or indirectly through other financial institutions) as loan pools that are held in trusts and administered by a trustee. The loan pools become asset-backed securities that are issued and sold to investors and are referred to as mortgage-backed securities. This process, often referred to as securitization (see fig. 1), plays an important role in providing capital for mortgage lending by generating funds that can be used to originate more loans. Investors assume the interest rate, prepayment, and credit risk associated with the loans backing these securities, unless they are covered by mortgage insurance or guarantees on the securities. The secondary market for residential mortgages consists of three major categories of securitizations—enterprise (Fannie Mae and Freddie Mac), Ginnie Mae, and private label. Fannie Mae and Freddie Mac are congressionally chartered, for-profit, shareholder-owned companies known as government-sponsored enterprises and have been under federal conservatorship since 2008. They generally purchase conforming loans, which are mortgage loans that meet certain criteria for size, features, and underwriting standards. In addition, the enterprises require that loans they purchase with loan-to-value ratios in excess of 80 percent have a credit enhancement mechanism, such as private mortgage insurance. Loans above this limit are known as jumbo loans. After purchasing mortgages, the enterprises create mortgage-backed securities and guarantee investors in these securities that they will receive timely payments of principal and interest. Ginnie Mae (a government corporation) guarantees securities that are issued by approved private institutions and backed by federally insured mortgages (FHA, VA, and USDA). Private institutions are also involved in the creation of private- label securities backed by mortgages that do not conform to the enterprises’ purchase requirements (because the mortgages are too large or do not meet specified underwriting criteria). Private securitizing institutions include investment banks, retail banks, mortgage companies, and real estate investment trusts. Other participants to a private securitization transaction include, but are not limited to, credit rating agencies that assess the creditworthiness of the securities and deal with underwriters hired by securitizers to market and sell the securities to investors. Each type of securitization retains a mortgage servicer to collect mortgage payments from borrowers and disburse interest and principal payments to mortgage trustees, who pass them to investors. Servicers also manage delinquent loans that may lead to loss mitigation (such as a loan modification or a repayment plan) with the borrower or foreclosure. The ATR/QM regulations set forth minimum requirements lenders must consider in relation to making the required good faith determination of a consumer’s reasonable ability to repay. To satisfy the ability-to-repay requirements, lenders generally must consider eight underwriting factors: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction (the monthly payment must be calculated based on any introductory rate or fully indexed rate for the loan, whichever is higher, and substantially equal, fully amortizing monthly payments); (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. To satisfy the QM requirements, the loan must meet certain restrictions on product features and points and fees as well as meet certain underwriting requirements. The loan must not have risky features such as negative amortization, interest-only payments, or balloon payments (except in certain circumstances). The term of the loan should not exceed 30 years. Point and fees should be less than or equal to 3 percent of the loan amount (higher percentages are allowed for loans of less than $100,000). Finally, the loan also must meet certain underwriting requirements. The creditor must take into account the monthly mortgage payment utilizing a fully amortizing schedule using the maximum rate that may apply during the first 5 years after the first payment. The creditor must consider and verify income or assets and current debt obligations, alimony, and child support. The rule also sets out three main categories of QMs that are presumed to comply with the ability-to-repay requirements: general, temporary, and small creditor. Under the general category, all loans to borrowers with a monthly debt-to-income ratio of 43 percent or less that meet the restrictions on product features, points and fees, and underwriting requirements described above are QMs. Under the temporary category, loans that meet the restrictions on product features, and points and fees described above, and are eligible for purchase, insurance, or guarantee by Fannie Mae, Freddie Mac, FHA, USDA and its Rural Housing Service, or VA are QMs, but are not subject to a specific debt-to-income ratio. Under the small-creditor category, loans must meet some restrictions on QMs such as product features and points and fees. Creditors must evaluate consumers’ debt-to-income ratio or residual income, but the loans are not subject to a specific debt-to-income ratio. Generally, these loans must be held in portfolio by a small creditor for at least 3 years. However, there is another category for small creditors in rural and underserved areas in which mortgages with balloon payments originated by such creditors can be QM loans. If a lender originates a mortgage that meets the QM requirements and has an annual percentage rate (APR) within certain limits, the lender is presumed to have satisfied the ability-to-repay requirements and receives certain protections from liability. That is, these QMs have a safe harbor (a conclusive presumption that the lender has satisfied the ability-to-repay requirements) that immunizes the lender from claims related to the borrower’s ability to repay. Lenders still can receive some protection from liability if they originate higher-priced QMs (those with APRs above certain limits). That is, lenders are still presumed to have satisfied the ability-to-repay requirements, but borrowers can rebut the presumption. Borrowers can try to prove that based on information available to the lender at loan origination, the borrower would not have enough income left for living expenses after paying the mortgage and other debts. Lenders also may make non-QM loans if they choose. However, these lenders will not benefit from the safe-harbor or rebuttable presumption liability protections afforded QM loans.