You Could Be Closer To Approval Than You Think
A mortgage applicant is often in a better home-buying position than their application suggests.
Their payments are high compared to their income, but they have strong credit or a lot of money in the bank.
Or, they spend very little on luxuries, and save everything.
These mortgage application “strong points” are known as compensating factors, and they can help you get approved, even when standard rules say you shouldn’t be.
There are almost an unlimited number of compensating factors depending on a mortgage applicant’s situation — from a high credit score to a track record of saving money.
Some mortgage programs, such as the HomeReadyTM program, have written compensating factor guidelines. Borrowers can use income from roommates and boarders to help their loan approval, for example.
Examine your situation, whether you have been turned down, or are applying for the first time. Ten common compensating factors can help you become a homeowner sooner than you expect.
Why You Might Need To Show “Compensating Factors”
Most lenders limit your debt payments to 43 percent of your income.
When the lender holds to this guideline, it can remove the possibility of homeownership to many who actually could afford a mortgage.
Many applicants look better in “real life” than they do on paper, for several reasons.
First, qualifying income is not the same as actual income or cash flow. For example, a self-employed applicant can deduct home-related expenses at tax time. The lender will deduct these costs from the applicant’s income. But those expenses would still exist if the applicant had an office job.
Second, some sources of income aren’t counted. Part-time or seasonal wages, commissions, or bonuses often aren’t taken into account without a long history of receiving them.
Lastly, your living expenses may be very low. This could enable you to put more money into a future house payment.
Also, mortgage applications don’t detail many expenses, or the lack thereof, that can make a difference in what you can actually afford. The following are just a few examples.
- Child care
- Medical bills
- Charitable contributions
- Dining out
Someone who has found ways to reduce costs of these and other expenses may be more capable of paying a mortgage than someone who earns and spends more.
10 Ways To Qualify For Your Mortgage
You can’t always overcome a denial due to a payment that, according to the lender, is too high for your income.
But if your lender says you don’t qualify, all hope is not lost.
An approval could still be in reach. Present your case to the lender. Mortgages are still approved by real people, and underwriters can overturn a denial with enough evidence that you can and will make your payment.
1. Apply For A Government-Backed Loan
The first step is to look at government-sponsored mortgage programs. FHA loans, as well as VA home loans and USDA mortgages are generally more accepting of compensating factors than are standard conventional loans.
In addition, you can often have debt payments that are as high as 50 percent of your gross income.
The combination of flexible features can get you into a home when you think you may not qualify.
2. Buy A Home That Requires Low Payments
“Payment shock” refers to an increase in housing expense caused by a new mortgage. If you’re paying $1,000 a month for rent, and your new mortgage payment (including principal, interest, property taxes and homeowner’s insurance) would be $1,500 a month, your payment shock is 50 percent.
If your new payment is $2,000, your payment shock is 100%. But the new payment is just $1,000, payment shock is zero.
Your lender will often assume that you can afford the new mortgage if it’s the same as your current rent. Your case is strongest when you have perfect payment history at your current rent for at least 12 months.
3. Save Two Or More Months Of Cash Reserves
Reserves are funds available to pay your mortgage if you experience an interruption in income. Reserves are measured in months. So if your prospective mortgage payment is $1,000, and after closing, you’ll have $3,000 in savings, you have three months of reserves.
When it comes to reserves, more is better. Lenders usually want to see at least two months of reserves for wage-earners and six for self-employed or commissioned employees.
You have a strong case if you have between two and 12 months of cash reserves after paying the downpayment and closing costs.
4. Demonstrate Conservative Credit Use
Lenders like to see that you have available credit, but are not using it.
For instance, you have three credit cards, each with $5,000 available balance. But you only have $1,000 balance across all of them.
You’re in a stronger financial position than someone with a higher income, but many maxed-out accounts. Available, unused credit signals fiscal responsibility: you know how to use, but not depend on, your credit accounts.
5. Make A Bigger Downpayment
Each loan type comes with a minimum downpayment amount. The lender wants to see that the home buyer has money invested in the transaction. The more money the buyer has invested, generally, the more likely they are to make their payments.
A higher-than-required downpayment is a strong indicator of a committed buyer. For instance, paying five percent down on an FHA loan, which only requires 3.5%, can turn a turned-down application into an accepted one.
Likewise, making any downpayment on a VA loan — even one percent — can result in approval.
6. Show A Pattern of Saving
Regular deposits into savings help you accumulate more funds for your downpayment and reserves. But that’s not the only benefit. Making monthly savings contributions proves that you’re financially responsible.
An added benefit: you can easily re-allocate the amount saved every month to your house payment, if needed. It’s an added layer of proof that you will make your future house payment faithfully.
7. Prove Additional Income
Some income can’t be counted in your qualifying ratios if there is insufficient history. Some examples of income that require history are income from a second job, commissions, overtime pay, and seasonal unemployment compensation.
However, the fact that you earn more in real life than on paper is considered a strong compensating factor by underwriters.
One newer loan program called HomereadyTM features an option to use income from non-borrowing household members as a compensating factor. Applicants who provide a history of living with roommates, family members, and others who contribute to expenses can be approved for total housing and debt payments up to 50% of their income.
8. Explain Future Income Potential
Those whose future income is likely to be significantly higher may qualify for larger mortgages.
This frequently applies to new college graduates in lucrative fields, or to those with credentials that will allow them to earn more — for example, a medical doctor who recently finished medical school and residency.
9. Buy An Energy-Efficient Home
The savings created by building or buying an energy-efficient home allow the borrower to direct more income toward paying a mortgage. “Energy-efficient” generally refers to homes built or retrofitted to exceed the International Energy Conservation Code standard.
10. Show A High FICO Score
Government-backed mortgage guidelines consider a FICO score of 680 or higher a compensating factor. This score indicates that the applicant has demonstrated debt management skills.
The average credit score was 685 in April for completed FHA loans, according to loan origination software company Ellie Mae. This could be one of the easiest compensating factors to provide to a lender.
What Are Today’s Rates?
Mortgage rates have been dropping in 2016, and this further helps mortgage applicants who had trouble qualifying just a few months ago.
Lower rates translate mean it’s easier to get approved, especially for mortgage applicants whose payments are high compared to their income.
Even if you have been turned down in the past, it’s an ideal time to get another home-buying analysis and rate quote.