Use compensating factors to justify higher qualifying ratios

In this age of automated underwriting, some loan reps forget that the qualifying guidelines within their software programs do not rule absolutely. If you fail some "standard" loan rule, you can still gain mortgage approval if you stress your compensating factors.

Types of Compensating Factors

What types of compensating factors will lenders consider? Virtually anything positive that reasonably demonstrates that you will faithfully pay your monthly obligations. Here are a dozen examples:

  1. Your rent payments equal or exceed the after-tax cost of your proposed mortgage payments.
  2. You save every month. You spend less than you earn. You shun destructive debt.
  3. You are traveling the fast track in your career. You frequently receive promotions and raises.
  4. For your age and occupation, you've built a high net worth.
  5. You maintain cash reserves to cover financial setbacks.
  6. You or your spouse earn extra income through part-time work, a second job, tips, bonuses, or overtime.
  7. You owe little or no monthly installment debt. No monthly payments often permits a higher housing cost ratio.
  8. You've been through a homebuying counseling program that helps homebuyers develop a realistic budget. FHA, Fannie, and Freddie lenders give special deals to first-time buyers who complete such programs. Many last only four hours, and they're well worth the time.
  9. You will make a down payment of 20 percent or larger.
  10. Your employer provides excellent benefits: auto, cash reimbursement for a home office, a superior health and dental insurance plan, large contributions to your retirement account, and so on.
  11. You earn an above average income. Budget-conscious people whose earnings exceed $4,000 or $5,000 a month often enjoy the financial flexibility to devote more money to housing than typical qualifying ratios indicate.
  12. Your nonhousing living expenses sit below average. You explain that you can afford a higher mortgage because: The home is energy efficient; you can walk to work or just drive a short commute; you reject costly vices (smoking, drinking); you spend conservatively: you backpack for vacations, drive a cream puff2002 Chevy, and buy clothes at outlet stores; you're handy with tools so you can perform your own household maintenance; your food costs are low because your parents supply you from their garden with all the fresh and home-canned vegetables you can eat.

Write Out Your Compensating Factors

After you list your reasons why you can afford the mortgage you want, don't just tell your loan rep. Explain in writing. Get supporting letters from your employer, minister, landlord, clients, customers, or anyone else who can vouch for your good character, creditworthiness, job performance, or personal responsibility.

Sometimes, too, it's a good idea to write out a family budget. Show your lender that your monthly income exceeds your monthly spending. (VA loans may actually require this step.) Then back up your budget with proof: financial records, cancelled checks, letters, and all of the compensating factors you can think of. With convincing written evidence, you'll break through qualifying guidelines that deter or delay ill-prepared borrowers.

These efforts do not merely help homebuyers; they also help beginning investors. Such preplanning conveys persuasive information about your ability to pay back the funds you borrow. It further shows the loan rep (and underwriter) that you prepare diligently and responsibly. You're not jumping into this investment without thinking it through.


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