What Are FHA Compensating Factors?

Something to appreciate about FHA loans is that approvals are not typically automated by a computer, but a real person looks at your application and determines whether to approve it or deny.  When you apply for a FHA loan, there is a reasonable degree of flexibility in the approval process. The guidelines for a FHA loan have set requirements, such as minimum credit scores and debt-to-income ratios.  Some good news though, is if your profile as a borrower is weaker in one area, but stronger in certain other ways, you still might get approved.  This strong areas are known to underwriters (those who review applications and process loans) as “compensating factors”.

What are the compensating factors that are considered?

• Savings / Assets – Having a lot of money in the bank, or assets such as stocks, bonds, and other accessible assets that can be turned into cash relatively quickly in the event of an emergency is a major compensating factor.  In the unfortunate event that you were to lose your job, having savings could help pay your mortgage payment until you find new employment.
• Larger Down Payment – When someone is able and willing to put down a larger down payment (more than the standard 3.5%), this not only will cause you to have a lower mortgage payment, but it tells the loan underwriter that you are serious about buying the home you want.  More importantly, having more money invested into a property is all the more incentive to keep up with the payments so that you do not foreclose and lose your home.  The FHA insures mortgages – it does not make them – but in the event someone defaults on their loan, lenders are protected from the loss by the FHA mortgage insurance you pay.
• Higher Credit – A higher credit score suggests that you are financially responsible and can be depended on to keep up with payments you are obligated to pay.  While credit scores are not the only aspect of a borrowers credibility, it is a huge gauge by which creditors determine your likeliness to pay your monthly debts.
• Low Debt – This is a critical part of any home loan application.  Having a lot of debt can cripple a person financially, and it also can be that someone has either been careless, irresponsible, or uncaring.  Of course, some people run into hard times resulting in debts being accrued.  All debts are closely evaluated to determine the financial responsibility of an applicant.
• Tenant History – If you have been a tenant at your current address for a long time, this can help your situation.  The longer the better.

There are also other considerations such as if your mortgage payment will be less than your current rent.  Or, as long as it is not 5% higher or $100 more than your current rent, this counts in your favor.

It is worth mentioning that the more compensating factors you have, the more leeway there is to have areas that are not met be overlooked.  If you would like to read the official HUD/FHA document concerning compensating factors, click here to read the PDF.

Or if you will also be renting out rooms (however, this doesn’t carry that much weight).

Let’s use some examples:  

• If you were to have a low credit score (below 620), but a lot of savings, this could compensate for the lower credit score.
• Another example would be if you were to have much higher credit scores, but also have high DTI ratios.  The higher credit scores might compensate for the higher debt-to-income ratio.
• Let’s say you have high DTI ratios, but you also have a lot of savings.  The savings suggest you have the option to pay off debts, or that if you were to be in a crunch, you could tap into the savings to use to pay your mortgage payment.

Again, your entire “profile” as a borrower is considered, which will allow for certain guidelines that are not met to be overlooked if there are redeeming aspects of your financial or credit situation.  If you are wondering if you might not be approved due to not being able to meet all of the requirements, it wouldn’t hurt to apply and see if any compensating factors exist that are sufficient to still be approved.