Compensating Factors in Mortgage on Manual Underwriting
In this blog, we will cover and discuss compensating factors in mortgage on manual underwriting. HUD compensating factors guidelines on FHA and VA loans are limited to certain factors. Not all positive factors can be considered compensating factors by mortgage underwriters. Compensating factors in mortgage are important on manual underwrites where underwriters need to go over the maximum threshold on debt to income ratios, marginal credit history, high payment shock, or other credit/income issues of the borrower. One of the main concerns of mortgage underwriters is that borrowers have the ability to repay especially manual underwriting files in higher-priced homes in high-cost areas.
What Is Automated Underwriting System Findings
Most lenders require all borrowers to get an approve/eligible per AUS in order to proceed with their mortgage process. There are times when Automated Underwriting System will not render an approve/eligible per automated findings. Or, in some cases, AUS will only approve borrowers with a much lower DTI than the amount allowed per HUD Guidelines. In cases when AUS will not honor HUD Guidelines, borrowers can be downgraded to manual underwriting.
What Loan Programs Allow For Manual Underwriting
Manual Underwriting is only for VA And FHA Loans. Fannie Mae and Freddie Mac do not allow manual underwriting on conventional loans. FHA and VA Manual Underwriting Guidelines are almost the same. Viewers of this blog can apply for VA loans as well. In this article, we will discuss and cover HUD Compensating Factors Guidelines On Manual Underwriting.
What Is Refer/Eligible Per Automated Underwriting System Findings
WHEN YOU GET A REFER ELIGIBLE AND YOU NEED TO GO THE MANUAL UNDERWRITE ROUTE: When most lenders deny borrowers when the desktop underwriter, AUS, renders a refer/eligible per Automated Underwriting System findings, CLN can underwrite refer/eligible AUS findings on VA and FHA loans with manual underwriting. One key factor in manual underwrites is timely payments in the past 24 months. We can exempt one or two 30-day late payments in the last 12 months but borrowers need to be timely in the most recent 12 months on timely payments. We will explain what Manual Underwrite is on this blog.
What Is Manual Underwriting
Manual underwriting is when the automated underwriting system (AUS) renders a refer/eligible per AUS versus an approve/eligible per AUS.
HUD Compensating Factors Guidelines On Manual Underwriting are the following:
- To get the higher debt to income ratios allowed, HUD requires two compensating factors
- Compensating Factors need to meet HUD guidelines on compensating factors
HUD Compensating factors in mortgage guidelines on manual guidelines have requirements borrowers need to follow regarding late payments last 12 and 24 months. I have covered that in the previous post. Today I will be covering HUD Compensating Factors Guidelines
What Are Specific HUD Compensating Factors in Mortgage Guidelines
Compensating factors are characteristics that allow you to do purchases at different debt to income ratios. If borrowers stay under or at 31% mortgage payment to gross monthly income (front end DTI) and 43% back end DTI(total monthly debts plus mortgage payment then borrowers) only need 1-month reserves to close their loan. The one-month reserve is the compensating factor. One-month reserves are your own money and one full mortgage payment.
Debt To Income Ratio Caps Depends On the Number Of Compensating Factors
If borrowers stay under 37% front end and 47% back end ratio they need a stronger compensating factor. We will be discussing more on manual underwrites with high debt-to-income ratios. If you want to go to the maximum FHA that allows for manual underwrite of 40/50 ratios then you need 2 compensating factors.
HUD Compensating Factors in Mortgage Guidelines On What Can Be Used As Compensating Factors
Compensating Factors are positive factors borrowers have. However, under HUD Compensating Factors Guidelines, the following are considered compensating factors:
- 3 Months Reserves are considered low compensating factors
- Verified and documented 3 months mortgage payments for 1-2 units are considered reserves
- 6 months mortgage payments for 3-4 units are considered comp factors
- Gift money cannot be used for reserves
- It must be borrowers’ own earned funds
- A low payment shock of 5% or less from what you were paying for rent and what your new housing payment will be is considered a compensating factor
Payment Shock Of 5% or Less Is Considered Compensating Factors in Mortgage
Verification of Rent is normally required on manual underwrites. If a borrower has a payment shock of 5% or less, this is a solid compensating factor. New total mortgage payment with taxes, insurance, and PMI cannot exceed 5% of the current verified rent payment or $100 dollars whichever is greater to be used as a comp factor. We need to verify the last 12-months of rent and/or mortgage payments (verification of rent or verification of mortgage) with no late payments.
HUD Compensating Factors in Mortgage Guidelines: Additional Income Of Borrower Not Used To Qualify
Verified additional income not being used in debt to income ratios. For example, we cannot use overtime, bonuses, or part-time income that hasn’t been averaged for 2 years. Borrowers who received it for one year would be a compensating factor. Non-borrowing spouse’s income does not count for additional income is another comp factor.
Residual Income on VA Loans
Strong Residual Income Is Considered Compensating Factors:
- This is a formula that you take Gross monthly income and subtract state income taxes, federal taxes, other income taxes, retirement income, new mortgage payment, child care expense, and utility expense
- Utility expense is calculated by taking the square footage of the house you are buying and multiplying it by 14
- Once you have this number refer to the chart below
- You must have more residual income than the number in the chart
BELOW IS THE CHART FROM HUD 4000.1 FHA HANDBOOK
Income as a Compensating Factor (continued) Table of Residual Incomes by Region
Table of Residual Incomes by Region
For loan amounts of $79,999 and below:
Size Northeast Midwest South West
1 $390 $382 $382 $425
2 $654 $641 $641 $713
3 $788 $772 $772 $859
4 $888 $868 $868 $967
5 $921 $902 $902 $1,004
Family size of over 5 Add $75 for each additional member up to a family of seven
Table of Residual Incomes by Region
For loan amounts of $80,000 and above
Size Northeast Midwest South West
1 $450 $441 $441 $491
2 $755 $738 $738 $823
3 $909 $889 $889 $990
4 $1,025 $1,003 $1,003 $1,117
5 $1062 $1,039 $1,039 $1,158
Family over 5 Add $80 for each additional member up to a family of seven. All manual underwriting requires one month’s reserves. So in the summary, if you are doing a manual underwrite and you are at 31/43 all you need is one-month reserves. If you are going to be at 37/47 borrowers will need one of the above factors plus the one month’s reserves required on all manual underwriting. If you are going to the maximum of 40/50 then you need 2 of the above. Please note that unlike most ratios programs you cannot exceed the front-end ratio on a manual underwrite.
Compensating Factors in Mortgage for High Debt To Income Ratios
Compensating factors on manual underwriting mortgages are required for borrowers with high debt to income ratio on manual underwriting. Compensating Factors are positive factors that offset risk by higher-risk borrowers. Borrowers with less than perfect credit and/or lower credit scores are considered to be higher-risk borrowers for lenders. Mortgage underwriters will look for compensating factors on manual underwriting files. Compensating factors can help get borrowers who need manual underwriting with poor credit, lower credit scores, and/or financial profiles to get approved for a mortgage.
When Are Compensating Factors in Mortgage on Manual Underwriting
Compensating Factors on manual underwriting mortgages are normally required on borrowers with higher debt to income ratios on manual underwriting. Compensating Factors are normally required on the following types of borrowers. Borrowers with a referred/eligible are candidates for manual underwriting downgrades. Mortgage Borrowers with credit scores under 620. Mortgage borrowers with high debt to income ratios: FHA 46.9% front end DTI and 56.9% back end DTI. Manual Underwriting Guidelines need to be followed on refer/eligible findings per AUS borrowers.
Refer/Eligible Findings Manual Underwriting Mortgage Process
Manual Underwriting Debt To Income Ratios can be capped up to 40% front end and 50% back end with two compensating factors. Otherwise, most lenders will cap debt to income ratio caps at 31% front end and 43% back end DTI with zero compensating factors. Here are examples of compensating factors:
- The borrower has a second job that is not used for qualifying income
- However, the second job needs to be seasoned for at least one year
- The borrower has verification of rent a payment shock is less than 5%
- The borrower has three months of reserves
- Reserves cannot be gifted and need to be borrowers’ own funds
- The borrower has a larger down payment than the minimum down payment required
- The borrower has a history of saving money
- The borrower has job longevity with a history of consistent wage increases and promotions
A larger down payment on a home purchase with lower debt to income ratio is considered a strong compensating factor.
High Balance Loan Amounts
There are many parts of the country where it is designated as high-cost areas. Many counties of California are in high-cost areas where the loan limits in high-cost areas are substantially higher than in traditional areas. Here are some basic facts on FHA Jumbo Loans and VA Jumbo Loans:
- Mortgage Rates may be higher
- Pricing Adjustments depend on the type of housing, credit scores, and down payment
- Lower debt to income ratio restrictions
- Automated Underwriting System Findings may require reserves
Compensating Factors in Mortgage Considered By Underwriters During Underwriting Process
Files that render a referred/eligible per AUS Findings need to be downgraded to manual underwriting. Manual Underwriting normally requires verification of rent and/or verification of mortgage. Debt to Income Ratios on manual underwrite is normally capped at 31% front end and 43% back end DTI with no compensating factors.
Number of Compensating Factors Allow Higher Debt to Income Ratio
With one compensating factor, the borrower’s DTI can be 37% DTI front end and 47% back end DTI. The debt to income ratio can be up to 40% front end and 50% back end with two compensating factors. We don’t have a debt to income ratio overlays on government and conventional loans. Debt to income ratio caps does not apply on FHA and/or VA Streamline Refinance.
Additional Compensating Factors in Mortgage For High-Risk Borrowers
Manually Underwritten transactions that are considered high risk are the following cases:
- High debt to income ratios
- Lower than 620 credit scores
- High payment shock
- No reserves
- Gift funds for the down payment
The mere fact that the mortgage borrower has a job and good credit is not considered compensating factor.
Factors That Can Be Used As Compensating Factors In Mortgage Qualification
Here are examples of compensating factors in mortgage qualification:
- Mortgage borrowers have little to no payment shock and have proven that they made timely rental payments in the past 12 months with no late payments
- The new housing payment shock is less than 5% of the current rental payment or lower
- The borrower is willing and able to put more than the minimum down payment required on the home purchase
- 10% or the more down payment on a home purchase without gifted funds is considered a compensating factor
- Mortgage borrowers who have three months of reserves and have a history of accumulating savings is a great compensating factor
- Borrowers having regard for credit and showing a history of re-established or established credit
Compensating Factors In Mortgage Qualification: Income Not Used To Qualify
Borrowers have documented income from other sources such as the following:
- part-time income
- bonus income
- overtime income but is not used as qualifying income
- For example, if a borrower has a part-time job for at least a year but not quite two years is considered a great compensating factor
If a new housing mortgage payment is less than the current rent payment, this is a huge compensating factor.
Partial Borrower’s Retirement Account May Count
Mortgage Borrower’s retirement accounts such as IRA, 401K, and Keogh Plans can be used as assets. In order to make sure that taxes and early withdrawal are covered, lenders only allow 60% of the vested dollar amount. A retirement account agreement must be provided and show terms of withdrawals under conditions other than in connection with the borrower’s employment termination, retirement, and death. Borrowers who have substantial non-taxable income can be grossed up by 15%. Mortgage borrowers who have obvious potential income increase potential either by training, certification, and/or education in their chosen profession is considered compensating factors.