FHA Compensating Factors Explained

by Heindrick So
November 3rd, 2008

During the mortgage process, many individuals often struggle to get past the approval process for various reasons. Especially during this credit crisis that we are experiencing, getting a loan approval can be quite difficult nowadays.  You read about it, you hear about it, and you see it on TV – but when you get denied a loan approval, it gets personal. The common response would be to reevaluate your application and simply ask “Why wasn’t I approved?”

Fortunately, one of the beauties of an FHA loan is the process of manual underwriting and compensating factors. For potential borrowers and those interested in FHA home loans, understanding how compensating factors work will give you the edge you need if your loan is on the borderline of an approval or denial.

Automated and Manual FHA Underwriting Explained
In the mortgage industry, lenders will typically advertise to originators that they use manual underwriting, use “common sense” underwriting, or accept files that “just make sense”. While a number of these are nothing more than just marketing gimmicks, potential borrowers need to understand the advantages of manual underwriting. Because of technology, when an FHA loan is submitted electronically, the approval/denial response can be instantaneous. This immediate automated underwriting saves time and reduces processing loads, but it can also be a disadvantage to applicants. 

With manual underwriting, human beings evaluate the file instead computers. As a result, if a file isn’t accepted under the black and white guidelines of automated underwriting, a manual underwriter could make certain exceptions because of specific compensating factors. 

Common FHA Compensating Factors
For FHA loans, compensating factors are used if a file is questionable or borderline in a specific guideline area. A compensating factor would mean that you surpass the minimum requirements of that guideline. The general rule is that you should have at least 3 compensating factors to compensate for an issue that falls out of guidelines. Here are a few common compensating factors that are considered:

  • - Larger down payment [i.e. putting down 10% instead of the required 3%]
  • - Source of down payment [underwriters favor you as the source rather than gifts or loans]
  • - Strong assets and reserves [more than minimum requirement in savings,checking,401k,IRA, stocks, bonds, etc..]
  • - Lower debt to income ratios
  • - Credit score and credit history [clean credit, length of clean credit, low utilization of credit accounts]
  • - Job stability and potential earnings [length of time on job, promotions and contracts guaranteeing salary in future]
  • - Homebuyer education classes
  • - Energy efficient homes [the savings can compensate for higher DTI ratios]

Compensating factors won’t work miracles, but it may just give you the extra boost you need to get approved. With manual underwriting, it is all about painting a picture for the underwriter demonstrating your financial abilities. Especially in this tight credit market, if you find yourself faltering in one area, you’d better brush up on a few of these compensating factors. 

Choosing the right loan agent is more important than ever when it comes to compensating factors. Experienced loan originators will know what will and won’t work, as well as which lenders will accept such compensating factors. To find the best FHA lender for you, compare a few lenders in your area using our FHA Lender Directory.

Suggested Reading: How to get an FHA mortgage with Non-Traditional Credit

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