Lenders Requiring Compensating Factors
This BLOG On Lenders Requiring Compensating Factors Was Written By Gustan Cho NMLS 873293
When are Lenders Requiring Compensating Factors?
- Factors that give the mortgage applicant strength when a mortgage loan underwriter evaluates the applicant’s mortgage application.
- Those mortgage applicants who cannot get an automated approval by the Automated Underwriting System, also known as AUS, may qualify via manual underwrite where the mortgage application is manually underwritten.
- With manual underwrites, positive factors are important.
- Also, those mortgage applicants with very marginal credit scores or high debt to income ratios, mortgage lenders look at borrowers as higher risk borrowers so this needs to be offset by positive factors.
- For example, mortgage applicants who have a history of 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 and positive factors needs to be addressed to offset the risk.
Offsets Risks & That Is Reason Lenders Requiring Compensating Factors
Layers of risk from the mortgage loan applicant must be offset by Lenders Requiring Compensating Factors .
- Lenders Requiring Compensating Factors are strengths on a mortgage loan application offsetting any 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 loan to close and having a mortgage loan denied.
- Mortgage loan applicants need to realize that all mortgage loans 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 FICO, many aged credit tradelines, and diversified types of credit are strong positive factors that will help borrowers.
- For example, strong factors with credit will be having a combination of 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 your credit scores.
- Liquid reserves of at least three months of principal, interest, taxes, and insurance are strengths for borrowers.
- The ability for the mortgage loan applicant to save is a strong positive factor. Saving patterns and saving history carries a lot of weight.
- Minimum payment shock, normally 20% or less is a strong positive factor.
- For example, if the mortgage loan applicant has rental verification of $1,000 per month and his proposed new housing payment of principal, interest, taxes, and insurance is $1,200, this is 20% 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 a mortgage applicant 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.
2017 Update On Lenders Requiring Compensating Factors
This BLOG has been updated on March 7, 2017 by Gustan Cho of The Gustan Cho Team at CrossCountry Mortgage.