Using Compensating Factors to Beef up Your FHA Application

The FHA insured loan offers more flexible underwriting standards that its cousins Fannie Mae and Freddie Mac. As a result, prospective Massachusetts home owners have been turning to FHA insured mortgage products more and more in recent years. HUD and FHA have recently announced their commitment to strengthen the FHA insurance fund and make sure that the FHA insured mortgage option is available for the next generation. This is a sugar coated way of saying that FHA doesn’t have enough money to back up its mortgage portfolio and in turn they have increased mortgage insurance premiums and are tightening up their underwriting guidelines. These changes come at a time when more and more renters are looking to get pre-approved for the first time, but don’t let this discourage you from the dream of home ownership. FHA has little known blue print to help you strengthen your lending profile so that your lender is giving you the answer you want to hear.

This blue print that FHA makes available to Massachusetts residents is found within the phrase “compensating factors”. Compensating factors are like a caffeine boost that can help push your mortgage application over the mountain and through the woods of mortgage underwriting.  coffee-cup-01Let’s say your credit score is on the lower range of what is considered acceptable by your mortgage lender, or your debt to income ratios are higher than what is typically allowed. You could utilize a couple of  compensating factors to beef up your application, or what is commonly called a 1003 by those “in the business”. By better understanding these compensating factors you can design a plan to add them to your mortgage application and bullet proof your transaction.


The following is a list of  FHA “Compensating Factors” that can be used to improve your

  • The borrower has successfully demonstrated the ability to pay housing expenses equal to or greater than the proposed monthly housing expense for the new mortgage in the most recent 12-24 months
  • The borrower makes a down payment ? 10% of the purchase price or for refinance transactions, there is a strong equity position
  • The borrower has demonstrated the ability to accumulate savings and demonstrates a conservative attitude toward the use of credit
  • The borrower’s previous credit history indicates the borrower is able to devote a greater portion of income to housing expenses
  • The borrower receives documented compensation or income not reflected in the effective income on HUD Form 92900-LT but directly affecting the ability to pay the mortgage, including food stamps and similar public benefits
  • There is only a minimal increase in the borrower’s housing expense
  • The borrower has substantial cash reserves (at least three months PITI) after closing
  • The borrower has substantial non-taxable income that was not grossed up when calculating the effective income
  • The borrower has a potential for increased earnings, as indicated by job training or education in the borrower’s profession
  • The home is being purchased as a result of relocation of the primary wage-earner, and the secondary wage-earner has an established history of employment, is expected to return to work, and reasonable prospects exist for securing employment in a similar occupation in the new area. Available employment must be documented in the file – No income for the trailing spouse is included in the ratios or when any of the above factors have been evaluated by automated underwriting and the loan receives a “refer” response, automated underwriting has determined the compensating factor is not sufficient to render a Total Scorecard Approve or Accept response. Alternative compensating factors must be provided for review.

Remember, preparation and education and the keys to a successful real estate transaction. Take the time to review your finances with your lender and ask him or her how compensating factors could turn your borderline application into a new home.


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