In this blog, we will cover and discuss Factors considered layered risk in manual underwriting. FHA and VA loans are the two loan programs that allow manual underwriting. When a VA or FHA loan gets a refer/eligible finding on the automated underwriting system, the file can still proceed with manual underwriting. Not all lenders are able to do manual underwriting. Many mortgage companies do not want to take manual underwriting files due to being riskier than AUS-approved files. When an approve/eligible per AUS file seems a little risky due to higher debt to income ratios, high outstanding collection balance, or other layered risk factors, the AUS-approved borrower can be downgraded to a manual underwrite. It is up to the underwriter’s discretion to manually downgrade an AUS-approved borrower. 

What Is Layered Risk in Manual Underwriting

Layered Risk comes into play with manual underwriting on VA and FHA Loans. Mortgage Underwriters go over a borrower’s credit and income profile with a fine toothcomb. Lenders understand that borrowers could have had prior bad credit and do not need perfect credit to qualify for mortgage loans.

If three of the following negative factors are presented on a particular mortgage borrower, mortgage underwriters will require compensating factors.

Compensating Factors are positive factors that offset layered risk in manual underwriting on borrowers and add integrity to the overall credit and income profile of borrowers. If four or more of the following risk levels in manual underwriting are present, credit approval cannot be granted.

List Of Layered Risk In Manual Underwriting

Manual Underwriting is available on FHA and VA Home Loans. Manual Underwriting is when Automated Underwriting System will not render an approve/eligible per AUS and renders a refer/eligible FHA and VA Loans during a Chapter 13 or right after Chapter 13 discharge without two-year seasoning are all manual underwrites.

Below are considered layered risks in manual underwriting:

• Work History that has been unstable the past several years with gaps in employment
• Rental Verification With Payment shock that exceeds 150%
• No credit tradelines and/or limited tradelines that have been active within the past 3 years for a minimum of 24 months duration
• Less than three credit tradelines
• Higher debt to income ratios
• 100% gifted funds

Layered Risk In Manual Underwriting Guidelines

Per manual underwriting guidelines, underwriters are supposed to assess risk in the following manner in the following paragraphs.

Primary Risk Assessment

Primary Risk Assessment:

• Borrowers down payments are assessed
• Loan to value is taken into consideration
• Larger down payment and lower LTV and equity are considered compensating factors
• The buyer has skin in the game
• Overall credit history and payment history is reviewed for all applicants
• Lower down payment and lower credit score borrowers are posed to have layered risk

Contributory Risk Assessment

Contributory Risk Assessment:

• High debt to income ratio
• Liquid assets and reserves
• Term of mortgage
• Mortgage and Rental payment history and payment shock
• Prior bad credit including housing events and/or bankruptcy
• Number of borrowers and/or co-borrowers

Comprehensive Risk Assessment

Comprehensive Risk Assessment:

• Lower down payment, lower credit scores, prior bad credit, no reserves after closing, high loan to value is indicative of high risk for potential mortgage default
• With such factors, investors will need to be convinced why the borrower will not default on their loan
• Need to provide evidence/compensating factors to offset layered risk factors in manual underwriting

Compensating Factors To Offset Layered Risk In Manual Underwriting

Here is a case scenario on layered risk in manual underwriting that is offset by compensating factors:

• The borrower has 580 credit scores
• Has older isolated bad credit 
• Putting down 10% on FHA Loan where it is above and beyond the 3.5% down payment required
• Borrowers have $30,000 in a bank account that can be liquidated anytime

This borrower has compensating factors to offset the isolated period of bad credit and low credit scores. So this borrower will be a good candidate for manual underwriting approval.

Factors Considered Layered Risks in Manual Underwriting By Mortgage Underwriters

Below are layered risks in manual underwriting considered by lenders:

• a high loan to value (95%)
• the middle credit score below 640
• no reserves after closing or minimal
• no prior mortgage history or rental (they have lived with parents or someone else and their contribution cannot be documented) and
• minimal credit to begin with
• self-employment for less than 2 years

The above are considered layered risks in manual underwriting by lenders and the home loan has a high chance of defaulting without compensating factors.

How Mortgage Underwriters Assess Self-Employed Borrowers

Risk Assessment for Self Employed Borrowers:

The first two years of self-employment are the toughest years. The first two years are the most important year of any start-up business. The first two years dictate whether the business is going to be in business or not. This is the main reason there is a two-year seasoning requirement for any self-employed borrower to qualify for a mortgage. Even for self-employed borrowers who have been in the same field for many years, starting a new business in the same field is risky. Often times nobody can predict how a new business will do. Time will tell.

Declining Income versus Growing Income on Self-Employed Borrowers

If the business has increased revenues then the business is likely to continue, grow, and succeed. However, if the business has declining revenues and is not profitable by the end of the second year, chances are that the business may not a success and may take more time to predict the profitability of the business. It takes a lot of start-up capital, time, and experienced people to start a new business. Mortgage Underwriters pay special attention and added layered risk in manual underwriting for self-employed borrowers.

Choosing The Right Lender

Not all lenders have the same mortgage lending requirements. Just because one lender is an FHA Approved Lender does not mean all lenders have the same lending requirements. All lenders need to meet government and/or conventional mortgage guidelines. However, each lender may have tougher mortgage guidelines than other lenders call mortgage overlays.

Agency Guidelines Versus Lender Overlays

Lender Overlays are mortgage guidelines that are above and beyond those of FHA, VA, USDA, Fannie Mae, and Freddie Mac. For example, to qualify for FHA Loans, HUD, the parent of FHA, requires a 580 credit score. Most lenders will require a 620 credit score on FHA Loans. This holds true even though HUD Guidelines state minimum credit scores to qualify for a 3.5% down payment home purchase FHA loan is 580. HUD Agency Guidelines allow borrowers with under 580 FICO and down to a 500 credit score to be eligible for an FHA loan with a 10% down payment. However, most lenders do not want anything to do with borrowers with under 580 scores and have lender overlays on credit scores. Although HUD allows 500 credit score borrowers, most lenders have lender overlays on credit scores due to risk.

Benefit of VA Loans

The United States Department of Veteran Affairs (VA) does not have any credit score nor debt to income ratio requirements. However, most VA Lenders will require a 620 to 640 credit score and they may have a 50% debt to income ratio cap. I just recently closed on a VA Loan with 597 credit scores and a 65% debt to income ratio because I got an approve/eligible per Automated Underwriting System. Gustan Cho Associates Mortgage Group has no lender overlays on government and conventional loans. Feel free to call or text us for a faster response at 800-900-8569. We are available 7 days a week, evenings, weekends, and holidays. Or email us at alex@gustancho.com.