FHA Manual Underwriting: 3 Compensating Factors

[ShanetheMortgageMan]

If you can’t get approved for an FHA loan through automated underwriting then your loan might need to be manually underwritten to get approved.  Having at least 3 compensating factors is a good rule of thumb when going for a manual underwriting approval (the more the merrier of course).  Compensating factors are when you are better off than whatever the minimum requirement is.  Compensating factors aren’t needed all of the time but if there is anything questionable or borderline about a person’s situation, they are better to have than not to have. Some compensating factors are: 

• More than the required down payment, 10% or more
• 3 or more months of reserves (PITI payment) in savings, checking, 401k, IRA, stocks, etc. (retirement accounts qualify at 60% of vested balance)
• Limited use of credit, such as low credit card balances, not a lot of accounts with balances The duration of time on the job/in the industry, there is no minimum required but 2 years work history is needed (except under special circumstances) and underwriters like it when you’ve been with the same employer for at least 2 years
• Down payment is your own rather than getting it as a gift or a loan
• Potential for increased earnings, such as an employer verifying you are in training or getting a raise in a few months, or you are in school getting a degree, certificate, or license that would make you a more valuable or skilled employee, or primary wage-earner is being relocated and secondary wage-earner has a history of stable employment, is seeking employment but has not found new employment yet
• Less than a 10% increase from your current housing payment to the new housing payment
• The new home is closer to work than your current home
• An energy efficient dwelling can allow expanded debt to income ratios
• There is income that can’t be used as qualifying income, such as a non-borrowing spouses, or employment income that has been received for less than the required amount of time, food stamps or public benefits
• Lower debt to income ratios, under 28% for housing & 41% for total
• Strong credit & scores, underwriters are looking for at least 12 months of clean credit, the longer credit has been clean past 12 months the better

[Donna1966]

Thanks for the info Shane!

I was wondering how I got my loan, now I see that we had several compensating factors!

Kudos!

Donna

[Anonymous]

Shane, great info to post!  I have to say that the potential for fuure earnings is what cinched my loan.  I became national board certified last year which is an additional $7500 ayear in my county...but of course it wasn't on my income tax yet--it made the difference for me getting my CTC!  I had DU approve/accept, but the underwriter used some of those factors to justify the loan...it was a close one because my husband is not on the loan...just me.

FHA was great--but whew!  What a ride!

Lisa 

[Anonymous]

Shane,

Thanks for another great post.  It sparked two questions from me:

• Could boarder (roommate) income be considered a compensating factor?  I'm looking at purchasing the home I am currently renting, and my two current roommates would stay on for at least another year or two, and they would sign a lease to that effect.
• Would the fact that I fully own a chunk of land (family inheritance) in another state help in any way as a compensating?  It's valued at $30k, but only semi-improved (cabin).

Again, thanks for your contined participation in the forums.

-RT

Message Edited by RandomTroubles on 10-28-2008 07:53 AM

[ShanetheMortgageMan]

You are welcome all, my pleasure.  I just felt that since a lot of people indirectly ask about it, it would be nice to have a thread here about it.

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@Anonymous wrote:

• Could boarder (roommate) income be considered a compensating factor?  I'm looking at purchasing the home I am currently renting, and my two current roommates would stay on for at least another year or two, and they would sign a lease to that effect.
• Would the fact that I fully own a chunk of land (family inheritance) in another state help in any way as a compensating?  It's valued at $30k, but only semi-improved (cabin).

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Yes, boarder income could be used as a compensating factor... but if it's not family/relatives could not be used as qualifying income.  The second part of your question will increase your net worth, which underwriters take a glance at and would obviously like rather than dislike, but I wouldn't list it as a compensating factor.

[Anonymous]

Shane,

You said "More than the required down payment, 10% or more" is a compensating factor.

FHA only requires 3.5%, so would a 5% dp be considered a compensating factor on an FHA loan? 

[Anonymous]

I'm not Shane but what I would say is this.

5% will look better than say 3.5% but is not in and of itself going to overide any major problem with your file.  The difference in risk to the lender is still about the same.  10% not only reduces the balance (therefore giving the seller more ioptions in a default situation, but proves more financial stability.  This gives the underwriter reason to overlook say a recent late or high DTI.  An extra 1.5 % is nto enough a difference to make large change in the file overall.  Again, if the file is borderline, putting down a couple grand extra might help.  But if you have a mark you are trying to get overidden the extra 1.5% will probabaly not be enough more by itself.

[DallasLoanGuy]

i have changed from 3.5% to 5% down on files and was able to change it from 'refer to manual' to 'approve' in automated underwriting

it counts. but 10% is the benchmark to be a compensating factor

[Anonymous]

I see I have compensating factors but in my loan application they were never asked for.

For example, I have a doctorate, therefore 9 years of college education and I work as a college professor (very stable) with a large grant which I will earn extra money from.  My LO didn't want to learn about future earnings only last years W2s. 

The LO never asked did we want to put down more than the required 3.5%.  We could put down somewhere between 5 and 10%.  We are a week into trying to get approved.  How can I change the amount I want to put down or is it too late?

[Anonymous]

The loan officer will definitely ask if you can put down more if it is necessary. 

One thing to clarify, if the overall fiel is strong, there is no reason for the LO or UW to worry about these.  They address these when they ssee a file that needs to be a little stronger to get approval.  It's not like they affect teh interest rates, etc.  It is just that they can use these factors to give you a little nudge over the top.  Think of it as a teacher looking at a student with a 59%.  If they have been working hard to catch up and are trying you might bump up their grade.  But, if they have made little effort and are just being lazy you may not bump up their grade.  If the underwriter's initial reaction is close, but no cigar on the file, compensating factors MAY change their mind.  If they are comfortable with the loan, then the factors aer somewhat irrelevant.