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Lenders Requiring Compensating Factors On Manual Underwriting

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Lenders Requiring Compensating Factors On Manual Underwriting

This BLOG On Lenders Requiring Compensating Factors On Manual Underwrites Was Written By Gustan Cho NMLS 873293 And UPDATED On April 2nd, 2018

When are Lenders Requiring Compensating Factors?

Compensating Factors are positive factors normally required on manual underwrites or borrowers with marginal credit and/or higher debt to income ratios. For manual underwrites with higher debt to income ratios, compensating factors are required.

  • Compensating factors gives strength to borrowers when underwriters evaluates the applicant’s mortgage file
  • Borrowers who cannot get an automated approval by the Automated Underwriting System, also known as AUS, may qualify via manual underwrite with a refer/eligible automated findings
  • where the mortgage application is manually underwritten. 
  • Some approve/eligible per AUS borrowers may need to be downgraded to manual underwrites
  • Positive factors are important on manual underwrites
  • Also, borrowers with very marginal credit scores or high debt to income ratios, are considered higher risk borrowers so this needs to be offset by compensating factors
  • For example, borrowers who have poor credit, high debt to income ratios, multiple open collections, declining income, unstable jobs, multiple jobs in short period of time, or other risk associated credit and/or financial profile on their mortgage application are considered higher risk borrowers
  • Positive factors needs to be addressed to offset the risk

Offsets Risks With Compensating Factors

Layers of risk from the mortgage loan applicant  must be offset by Lenders Requiring Compensating Factors 

  • Lenders Requiring Compensating Factors are strengths of borrowers
  • Offsetting risk factors which help to demonstrate the borrower’s willingness and ability to repay the  mortgage loan
  • These factors often times can be the difference between getting a mortgage approval or mortgage loan denial
  • Borrowers need to realize that all borrowers have a certain degree of risk factors
  • Therefore, by combining these risk factors by offsetting it with compensating factors will dramatically improve the chances of the mortgage loan defaulting

Here Are Some Examples Of Compensating Factors

  • High residual income (average is $1,200 for a single person household and $2500 for a 2+ person household)
  • Low Debt to Income Ratios which is normally 5% or more under the mortgage program guidelines.
  • Long credit history with high credit scores
  • Credit scores that are over 720
  • Multiple aged credit tradelines
  • Diversified types of credit are strong positive factors that will help borrowers.
  • For example, strong factors with credit will be having a combination of the following:
    • credit card payment history
    • auto loan payment history
    • installment loan payment history
    • personal loan payment history
    • mortgage payment history
  • Having different types of credit accounts versus just credit cards or just installment loans are not just viewed favorably but will also maximize credit scores
  • Liquid reserves of at least three months of principal, interest, taxes, and insurance are strengths for borrowers
  • The ability for borrowers to save is a strong positive factor
  • Saving patterns and saving history carries a lot of weight
  • Minimum payment shock, normally 5% or less is a strong positive factor. 
  • For example, if borrower has rental verification of $1,000 per month and his proposed new housing payment of principal, interest, taxes, and insurance is $1,050, this is 5% payment shock and is considered a positive favorable factor
  • Larger down payment than the minimum down payment required is considered strong favorable factors
  • Verifiable housing history (verified through a Property Management Firm or 12 months bank statements/cancelled checks showing a minimum of 0x30x12)
  • Own sourced funds versus gift funds is considered strength for borrowers
  • Employment history
    • Longevity on the current job shows and carries a lot of weight versus multiple jobs in the past two years
  • Consistent pay increases and/or job promotions shows stability and likelihood to remain employed with future promotions and pay increases shows strength and stability
  • Verified income but income that cannot be used shows strength and a great positive factor
  • For example, if borrower has held a part time job or has overtime income for the past 18 months, this income cannot be used because the minimum required for part time job and/or overtime income is at least a 24 month history.
  • This is verifiable income but cannot be used for income qualification

Examples Of High Risk Factors

The following items are considered high risk by mortgage loan underwriters and are cases where Lenders Requiring Compensating Factors:

  • Little to no cash. 
    • Down payment being gifted
    • Having limited or no reserves
  • Minimal down payment and 100% gift funds for down payment
  • Poor credit history and recent late payments
  • No rental verification
  • Short term credit tradelines and limited credit
  • High debt to income ratios
  • Job hopping and job gaps in the past two years
  • Declining income
  • Irregular income

Manual Underwriting

Manual Underwriting is allowed with FHA Home Loans and VA Loans. To be eligible for manual underwriting, borrowers need timely payments in past 12 months. Verification Of Rent is required on manual underwrites. The Gustan Cho Team has no mortgage overlays on government and conventional loans on FHA and VA Home Loans.

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