This BLOG On Lenders Requiring Compensating Factors On Manual Underwrites Was Written By Gustan Cho NMLS 873293 And UPDATED And PUBLISHED On October 1st, 2019
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 evaluate 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 need to be addressed to offset the risk
In this article, we will cover and discuss the importance of compensating factors on manual underwriting.
Minimizing Risk With Positive Factors
Layers of risk from the mortgage loan applicant must be offset by Compensating Factors
- 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 Borrowers With Minimal Risk 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.
Strong Positive Strengths Of 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.
Ability And History To Save
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 a 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/canceled checks showing a minimum of 0x30x12)
Own sourced funds versus gift funds are considered strength for borrowers.
Employment History And Job Stability
- 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 show strength and stability
- Verified income but income that cannot be used shows strength and a great positive factor
- For example, if the 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 a part-time job and/or overtime income is at least a 24-month history
This is a 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 the 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 is allowed with FHA Home Loans and VA Loans. To be eligible for manual underwriting, borrowers need timely payments in the past 12 months. Verification Of Rent is required on manual underwrites. Gustan Cho Associates has no mortgage overlays on government and conventional loans on FHA and VA Home Loans.