What Are The FHA Compensating Factors?

When you're trying to qualify for a mortgage, lenders consider your credit score, how much debt you have, the regularity of your income and your savings, among other factors. If you don't meet the lender's requirements in one or more of these areas, you may have to work on them before you can be approved.

However, you may still be able to qualify for a Federal Housing Administration (FHA) loan with an uneven application. Let's say you ran up some debt in college, but you’re working on it, and you have some savings. Maybe you have credit history with a couple of dings, but you have plenty of income and steady employment. These positives are called FHA compensating factors, and they could help you qualify for an FHA loan.

What Is A Compensating Factor And When Are They Needed?

The best way to think of a compensating factor is as a point in your favor that looks good to an underwriter, which is the person making an evaluation of whether you qualify for the mortgage. These compensating factors make up for the fact that you may have some work to do in other areas.

As an example, a borrower who has a low credit score, low income or a high debt-to-income ratio (DTI) may be able to make up for this by having strong compensating factors in other areas of their application.

FHA Guidelines

Before getting into compensating factors, you should know some of the basic guidelines for getting an FHA loan. You need a median credit score of at least 500. But, to qualify with a score that low, you need a 10% down payment or equity amount.

However, it’s worth noting that lenders set their own policies. Most lenders, including Rocket Mortgage^®, require 3.5% down with a 580 FICO^® Score.

FHA Underwriting Process

In many cases, loans can go through an automated approval system. If the computer determines based on the information gathered that you present an acceptable risk to the FHA, you can move forward.

If your application is rejected by the system, a lender may still be able to manually underwrite your loan. The FHA has strict limits on the amount of your gross monthly income that can go to your mortgage payment and your overall DTI. For example, to qualify with a credit score of 580 and above under manual underwriting, any hypothetical mortgage payment could cover no more than 31% of your income, and leave you with an overall DTI of no more than 43%.

If you have certain compensating factors, your housing expense ratio on a manually underwritten loan can be as high as 40% and your overall DTI as high as 50%, enabling you to qualify with slightly higher monthly payment requirements. So the compensating factors can be very important.

Lender Policies For Manual Underwriting

What Are The Compensating Factors That Are Considered By Lenders For FHA Loans?

There are several compensating factors that are considered by a lender for an FHA loan.

Savings And Cash Reserves

When you qualify for a mortgage, lenders often want to see that you have a certain number of months’ worth of mortgage payments, with the idea being that in the event of a loss of income, you could sustain your mortgage payment for a while. This is referred to as having cash reserves.

According to the FHA, it can be considered a compensating factor if you have three mortgage payments in savings when you’re buying up to two units. If you’re buying three or four units, you’ll need 6 months’ worth of mortgage payments.

Reserves are a big part of the reason that mortgage lenders check your assets. They want to know that you have savings available. Under FHA guidance, assets can be anything not used to pay closing costs as long as they aren’t gifts, borrowed or cash received from the mortgage closing.

Low Debt

Your debt-to-income ratio is one of the big things that determines exactly how much you can afford along with your down payment and interest rate. In order to calculate it, you add up your installment and revolving debts and divide it by your gross monthly income. Move the decimal over two places to express the result as a percentage.

The lower your DTI, the better. If you have a very low DTI going into getting a mortgage, you have room for a bigger house payment. However, keeping a low DTI of no more than 36% or so can send a signal that you’re not overextending yourself.

A significant debt-related compensating factor according to the FHA is having no discretionary debt. In other words, the only thing that’s not paid off every month is your mortgage payment.

Residual Income And Steady Employment

If you have steady employment, you’ll always have money coming in. Because of this, you’re viewed as more likely to be able to make your mortgage payment.

Residual income is defined as the amount of pretax income you have after accounting for personal debts and expenses. If you have a fair amount of money left over at the end of the month, this is viewed positively because you would be able to better handle a decrease in income if you had to.

Other Income

When applying for a mortgage, a lender is most concerned about the income you receive on a regular basis as part of a salary or hourly rate because that’s something that’s likely to continue moving forward. That doesn’t mean your other income counts for nothing.

If you have a high level of income from any of the following categories that you’ve received in the past, it could help your chances to qualify:

• Overtime
• Bonuses
• Part-time work
• Seasonal income

Larger Down Payment

Although not specifically listed as a compensating factor by the FHA, having a larger down payment makes you less of a risk for a lender. This is because your monthly payment is relatively lower than someone who makes a smaller down payment.

You also are often considered less likely to default because you’ve made a large upfront investment. That indicates you’ll keep up with the payment because you don’t want to lose what’s been put in already.

Good Credit History

Also not specifically listed as a compensating factor, a higher credit score can help your chances of getting approved for a mortgage. Lenders and the FHA will often allow you to qualify with a higher DTI ratio with a higher credit score, especially if approved through the automated underwriting system that the FHA has.

In addition to your down payment, your credit score is a key thing that influences your interest rate. In general, the higher your score, the better.

A good credit history shows the lender that you’re more likely to make your monthly mortgage payments. In addition to the score itself, they’ll look at what’s shown on your credit report. If it’s clear of red flags like late payments and collections, all the better.

FHA Compensating Factors FAQs

Still have questions? Check out some frequently asked questions.

Do I qualify for an FHA loan?

Most lenders, including Rocket Mortgage, require 3.5% down with a 580 FICO^® Score to qualify for an FHA loan. However, with FHA compensating factors, you may be able to qualify for a loan even if you don’t meet all the requirements. Each lender will have different thresholds, so you’ll need to research to figure out if you qualify with a specific lender or not.

What is the FHA Compensating Factors Chart?

The U.S. Department of Housing and Urban Development (HUD) has a chart that details the FHA’s manual underwriting compensating factors. See the FHA Acceptable Compensating Factors chart in the FHA Single Family Housing Policy Handbook.

What is an FHA energy-efficient mortgage?

An energy-efficient mortgage, or EEM, is a loan product with relatively favorable terms that allows borrowers to purchase a home or refinance their mortgage while making energy-efficient renovations. They are available for conventional loans as well as VA and FHA loans.

FHA loan EEMs are popular loan choices for many home buyers because the DTI requirements aren’t quite as stringent. Also, by making your home more “green” friendly, you can save money on monthly utility bills.

The Bottom Line

If you’re on the edge of qualifying for an FHA loan, compensating factors can help you get approved. They might particularly benefit you if you have a lower credit score or need to qualify with slightly higher debt.