What Are Compensating Factors?
Compensating factors are favorable circumstances that help mortgage loan borrowers who are marginal credit mortgage loan borrowers who barely met the bare minimum mortgage qualification requirements set by both FHA and Fannie Mae mortgage lending guidelines and barely met the mortgage lender’s minimum internal lending criteria. For example, if the minimum credit scores to qualify for a FHA insured mortgage loan is 580 FICO and the maximum debt to income ratio is 56.9%, the subject mortgage loan borrower just met these minimum requirements, compensating factors will be extremely helpful for this mortgage loan borrower. Examples of compensating factors are reserves, verification of rent, extra credit tradelines, working spouse who is not on the mortgage loan, and assets. A good letter of explanation detailing the mortgage loan borrowers compensating factor attached with the mortgage application will make the mortgage application much stronger and give more confidence for the mortgage loan underwriter in issuing a mortgage loan approval.
Examples Of Compensating Factors That Will Solidify Your Mortgage Loan Application
- The mortgage loan borrower has verification of rent that can be proven via cancelled checks for at least 12 previous months. 24 months verification of rent will be a stronger compensating factor. Rental payment that is close to the new mortgage payment will be considered a compensating factor because there will be no or very rental shock payment.
- The mortgage loan borrower makes a down payment greater than the bare minimum required. This is a strong compensating factor because it proves to the mortgage loan underwriter that the mortgage loan borrower has more skin in the game and the mortgage lender has less risk due to the stronger down payment. More equity investment from the mortgage loan borrower means less risk for the mortgage lender and a stronger borrower.
- The mortgage loan borrower has strong assets and reserves and has established credit history or a re-established credit history with no late payments after a bankruptcy and/or foreclosure. Maxed out credit cards or too much credit with high balances are not considered compensating factors and will scare away mortgage lenders because it shows financial irresponsibility as well as the borrower living beyond his or her means.
- The longer the borrower’s credit history from his or her credit report shows the overall character of the mortgage loan borrower.
- The mortgage loan borrower has part time income or overtime income that has not yet been seasoned for two years so it cannot be used for income qualification but shows that the borrower has extra income. This is considered compensating factors for the borrower and the mortgage loan underwriter will take this into consideration.
- There is only a minimal increase in the borrower’s housing expense so there is no payment shock. The borrower will not go from paying zero rent to a mortgage payment of $2,000.
- The mortgage loan borrower has cash reserves for at least three months of housing payments and has other assets. This is a huge compensating factor that is viewed extremely favorably by mortgage loan underwriters.
- The mortgage loan borrower has non taxable income whether from social security and/or pension income that has not been grossed up by 25% during income qualification.
- The mortgage loan borrower has advanced training in his field such as advanced degrees and/or specialized training that indicates the likelihood of the mortgage loan borrower being marketable in his or her field and shows a promotion or income advancement likely in the very near future. For example, a police officer with a law degree versus a police officer with a high school diploma. The law degree will be considered a compensating factor due to the likelihood that he or she will have a greater chance of employment and/or advancement due to his advanced education in the event if he or she were terminated or injured on the job.
Are compensating factors necessary
If you are a mortgage loan borrower in Illinois, Florida, Wisconsin, Indiana, or California, I represent wholesale mortgage lenders that have no overlays which means that as long as you get an approve/eligible per DU Findings via Fannie Mae Automated Underwriting System, you are pretty much guaranteed a mortgage loan approval as long as all of your information that you listed on your 1003 mortgage application can be verified so compensating factors will not be necessary. Compensating factors are nothing more than security blankets. However, if you are dealing with a bank or mortgage banker that do have overlays, then compensating factors will be important. If you are a home buyer and have marginal credit and need a mortgage loan approval, please contact me at 262-716-8151 or visit me at www.gustancho.com. Many of my clients are mortgage loan borrowers who have been denied by banks and mortgage bankers who come to me via referrals that I am able to help them close on their residential mortgage loans.