Compensating Factors For Manual Underwriting
In this blog, we will cover what mortgage lenders consider compensating factors for manual underwriting on FHA and VA loans. FHA and VA loans are the only two mortgage loan programs allowing manual underwriting. Compensating factors are positive factors that add strength to borrowers. Mortgage lenders will take strong compensating factors for manual underwriting because it offsets risk by borrowers. Compensating factors for manual underwriting are considered for high debt-to-income ratio borrowers.
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What Type of Borrowers Need Compensating Factors For Manual Underwriting
Larger down payments, cash reserves, rental verification, low debt-to-income ratios, and job longevity are examples of compensating factors. Comp factors are extremely important for borrowers who need FHA or VA manual underwriting who have the following:
- lower credit scores
- recent late payment
- high debt to income ratios
- 100% gifted funds and no funds of their own for the down payment
- prior bankruptcy
- foreclosure
- deed in lieu of foreclosure
- short sale
- those mortgage applicants who cannot get an approve/eligible per DU FINDINGS and need a manual underwrite
In this article, we will discuss and cover Compensating Factors Considered By Lenders On Manual Underwriting.
Who Needs Compensating Factors For Manual Underwriting?
Compensating Factors are very important for all FHA and VA manual underwriting borrowers. Mortgage Underwriters will look for comp factors by the following types of borrowers:
- 580 credit score
- very little to no credit tradelines
- late payments after housing event or bankruptcy
- no verification of rent
- multiple job changes in the past 2 years
- unpaid collection accounts
- no reserves or down payment
- down payment to be gifted
- multiple late payment history
Borrowers with the above types of credit history are borrowers who will most likely need compensating factors.
What Are Strong Compensating Factors?
The layers of risk a mortgage lender is faced with need to be offset by one or many comp factors for borrowers with weak credit and financial profiles. Compensating factors are viewed as positive strengths for borrowers. Comp Factors offsets the risk factors lender faces. It also helps demonstrate the borrower’s willingness and ability to pay the mortgage loan. All mortgage loans have a degree of risk factors. Using the many risk factors weak credit profile borrowers faces and adding the compensating factors the applicant has can greatly increase the chances of a mortgage loan approval.
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Examples Of Positive Compensation Factors For Manual Underwriting
High residual income is one of the best compensating factors for mortgage underwriters.
- A residual household residual income of $1,200 for a single-person household
- For a two-plus person household, a $2,500 residual income is considered a favorable compensating factor
Low debt to income ratios is considered a comp factor.
- What is a lower debt-to-income ratio to be considered a positive comp factor?
- A debt to income ratio that is lower than 5% or more than the mortgage loan programs maximum requirement is considered a positive compensating factor
A higher credit score and positive credit history with longevity are considered positive compensating factors in the views of a mortgage lender.
- Higher credit scores that are 720 or higher are comp factors
Various types of credit tradelines with longevity are considered positive and good compensating factors.
Reserve Requirements On Manual Requirements
Reserves, cash in the bank, is a strong compensating factor. 3 to 6 months of reserves which include principal, interest, taxes, and homeowners insurance are considered reserves. A history of the saving pattern is a very strong compensating factor:
- Investment accounts
- CD’s
- mutual fund investment accounts
Borrowers with the above accounts prove financial responsibility and the eagerness of borrowers to save.
Verification Of Rent
Rental verification is a strong compensating factor. Rental verification is only valid if the mortgage loan applicant can provide 12 months of canceled checks and/or bank statements paid to the landlord. For those renters who are renting from a registered property management company, a VOR FORM provided by the lender and completed and signed by the property manager is a valid rental verification and can be used in lieu of canceled checks.
Payment Shock For Compensating Factors For Manual Underwriting
Low payment shock is a strong compensating factor. For example, if the renter is currently paying $1,000 in rent and the proposed new housing payment that includes principal, interest, taxes, and insurance is $1,050. This is a strong good comp factor due to low payment shock. Up to 5% or less payment shock is a strong comp factor.
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Down Payment On Home Purchase
A larger down payment than the minimum required is considered a strong compensating factor. For example, if the minimum down payment required is 3.5% on a home purchase:
- The home buyer wants to put a 10% down payment
- This is considered a strong comp factor
Less risk on the mortgage lender because the home buyer has more skin in the game.
Compensating Factors For Manual Underwriting on FHA Loans
FHA loan programs require a minimum of 3.5% down payment. 100% of the down payment can be gifted by a family member and/or relative of home buyers. If borrowers have their own funds for the down payment instead of getting 100% funds gifted for the down payment, it is considered stronger borrower. It adds more weight to the financial and credit strength of the borrower.
Employment Guidelines on Manual Underwriting
Employment history and a history of income increases are strong comp factors. Also, verified income but income that cannot be used is considered strong compensating factors. For example, to be able to use overtime or part-time income, borrowers need a 24-month history. If borrowers only have 18 months of overtime or part-time income, it cannot be used as income since it is short of the 24-month requirement. However, overtime and part-time income can be verified. This verified income is a comp factor even though it cannot be used for income qualification purposes.
Compensating Factors For Manual Underwriting To Offset Risk Factors
There are several factors that mortgage lenders view as risk factors. Mortgage lenders view limited reserves as high-risk factors. Smaller down payments or minimum down payments are considered risk factors versus larger down payments by home buyers. No rental verification and weak credit payment history are also considered risk factors by lenders. Limited credit and credit history are considered risk factors. High debt to income ratios are definitely risk factors and so are gifted funds for the down payment.
What Are Compensating Factors Considered By Lenders
To summarize, compensating factors only come into play on manual underwriting files on borrowers with higher debt-to-income ratios. For more information on this blog or other mortgage-related topics, please contact us at Gustan Cho Associates at (800) 900-8569 or text us for a faster response. Or email us at alex@gustancho.com.
Gustan Cho Associates is a mortgage company licensed in multiple states with no lender overlays on government and conventional loans. We also have a national reputation of being a one-stop mortgage shop due to having dozens of non-QM and alternative lending programs on owner-occupant homes, second homes, and investment properties. The team at Gustan Cho Associates is available 7 days a week, on evenings, weekends, and holidays.
Frequently Asked Questions (FAQs)
- What are compensating factors for manual underwriting?
Compensating factors are positive attributes that can offset potential weaknesses in a borrower’s financial profile, allowing manual underwriters to approve a loan that might not meet standard automated underwriting guidelines. - Why are compensating factors important in manual underwriting?
Compensating factors offer manual underwriters extra evidence of the borrower’s ability to repay the loan, thereby decreasing the risk associated with lending to individuals who might not meet traditional lending standards. - What are examples of compensating factors?
Examples of compensating factors include a high credit score, significant cash reserves, stable employment history, low debt-to-income ratio, a large down payment, and a history of timely rent payments. - How do compensating factors for manual underwriting affects the underwriting decision?
Compensating factors can strengthen borrowers’ application by demonstrating their financial stability and ability to manage debt responsibly, potentially leading to loan approval or more favorable loan terms. - Can compensating factors compensate for poor credit?
While compensating factors can help mitigate certain weaknesses in a borrower’s credit profile, they may not fully offset severe credit issues. However, strong compensating factors could still improve the overall strength of the loan application. - Who determines which compensating factors are acceptable?
To approve the loan, the underwriter evaluates the borrower’s financial situation, including compensating factors. Lenders may have specific guidelines regarding which compensating factors they consider acceptable. - How can borrowers strengthen their compensating factors?
Borrowers can strengthen their compensating factors by improving their credit score, saving more money for a down payment or reserves, maintaining stable employment, reducing debt, and demonstrating a consistent payment history. - Are compensating factors required for all manually underwritten loans?
While compensating factors are often necessary for manually underwritten loans, the requirements may vary depending on the lender’s guidelines and the borrower’s financial situation. - Can compensating factors help borrowers qualify for a larger loan amount?
Strong compensating factors may allow borrowers to qualify for a larger loan amount than they would otherwise qualify for solely based on their income and credit profile. - What should borrowers do if they believe they have strong compensating factors?
Borrowers should communicate with their lender and provide documentation supporting their compensating factors to strengthen their loan application during the underwriting process.
