My Perfect Mortgage
Compensating Factors Enhancing Mortgage Approval Chances
7 minute read
December 21, 2022

Would-be homeowners sometimes avoid moving forward because they think their financial profile is sub-par.

You could be weak in credit or have not quite enough income to qualify to purchase the house that you want. But the mortgage industry considers what are known as compensating factors. If you have a couple of these, they may be able to overcome weaknesses elsewhere in your profile.

See if you are eligible for a home loan.

What are compensating factors?

Compensating factors are strengths in your financial profile that can be used to offset weaknesses. The underwriter looks for tangible reasons to approve the loan.

A mortgage lender may be reluctant to approve your application with a poor or fair credit score. But if a lower-credit applicant has $100,000 in savings after making a down payment, that's a completely different story.

Skilled mortgage personnel will know how to develop compensating factors that will offset negatives in your profile. But you should still know what they are so that you can help your own cause.

Typical compensating factors

Here are common compensating factors that can be used to overcome weak credit, insufficient income, or other risk factors in your file.

Large down payment. Most borrowers are in a minimum equity position, particularly when it comes to purchasing a new home. If you make a down payment equal to at least 20% of the purchase price, this is a compensating factor that will it make easier to approve your loan.

Low non-housing debt. If you have a small car payment, no student loans, and a $25 minimum credit card payment each month, you have very low non-housing debt. Thi can help if your "housing debt" -- mortgage payment, property taxes, and homeowners insurance -- are on the high side.

Small increase (or decline) in house payment. A strong compensating factor is when the new house payment will be no more than 10% higher than the current one -- either rent or mortgage. The lender can reason that if you've successfully managed a comparable house payment in the past, you will have little trouble in the future.

Large cash reserves after closing. Cash reserves are liquid savings that you have available after the closing. Lenders generally require that you have an amount sufficient to cover at least two months of the new housing payment. If you have significantly more, say at least six months' worth, this can be a compensating factor.

Large asset base. Some people with relatively modest incomes are skilled at acquiring a large amount of savings. This can be in the form of money in bank accounts, or investments and retirement savings. A large asset base is a strong compensating factor, even if you don't use it to increase the down payment. It is an indication of overall financial strength that makes it less likely that you will default on the mortgage.

Additional income not used to qualify. Sometimes the reason for insufficient income is income that is not recognized by the mortgage lender. For example, if you receive bonuses or overtime, the lender will not use it to qualify unless it has been happening for at least two years. But if you have been receiving it for over one year, that represents a compensating factor, even though it is not used to qualify you for the loan.

See if you have adequate compensating factors to qualify.

Strong career growth potential. This is a factor that primarily benefits younger borrowers. Let's say that you are recently out of school, and not making a lot of money. The lender may be willing to stretch the income guidelines if you're working in a career that has strong upside potential. For example, this can include being a doctor right out of medical school, or an engineer or IT professional right out of college. Though your income may be low now, it's easy enough to project that it will rise rapidly soon.

Exceptional credit history. This can be a compensating factor if income is a problem. The fact that you have managed your credit well in the past, evidenced by a credit score of something like 800+, can be a compensating factor.

There are other compensating factors, but these are some of the more common ones. If you are weak in any areas of your loan application, you should determine how many of these might apply to your situation.

FHA compensating factors

FHA lenders rely on a computerized decision when they underwrite loans -- most of the time.

But some lenders perform "manual underwriting" in which a human reviews the file and makes a decision. If you're denied an FHA loan, find a lender that can do a manual underwrite.

Compensating factors help you qualify with higher debt-to-income ratios. This is true for any FHA loan, but especially with a manually underwritten one. Following are compensating factors and what DTI you can have in each case.

31/43 DTI ratio example:

  • "31" is the percentage of gross income toward your future housing payment
  • "43" is the percentage of gross income toward future housing plus all other debts
Credit ScoreMax DTICompensating Factors (manual underwriting only)
500-57931/43N/A. Financial compensating factors can't overcome a credit score below 580 with higher DTI
No credit score/thin credit31/43N/A. Financial compensating factors are not considered for higher ratios
500-579 or insufficient credit33/45Qualified energy-efficient upgrades are made to home (FHA EEM mortgage)
580+31/43No compensating factors required
580+37/47One of:
• Cash reserves equal to 3 months of total housing payment for 1-2 units and 6 months for 3-4 units
• New housing payment less than $100 or 5% more than previous housing payment (whichever is less) with no 30-day late payments in last 12 months
• Monthly disposable or "residual" income between $390 and $1,158 depending on household size and U.S. region
580+40/40No monthly debt (you must have credit lines at least 6 months old with zero balance and proof credit card/revolving debt has been paid off for the last 6 months)
580+40/50Two of the following compensating factors:
• Cash reserves equal to 3 months of total housing payment for 1-2 units and 6 months for 3-4 units
• New housing payment less than $100 or 5% more than previous housing payment (whichever is less) with no 30-day late payments in last 12 months
• Significant additional income not counted toward qualifying income such as part-time or seasonal employment documented for one year but less than two
• Monthly disposable or "residual" income between $390 and $1,158 depending on household size and U.S. region

Those with lower income can still be approved for FHA loans. You just need to know about compensating factors, and in some cases, point them out to your lender. Many mortgage loan officers don't even know the above rules.

Connect with an FHA lender that can do a manual underwrite.

Weaknesses that compensating factors can overcome

The two most common weaknesses center around credit and income. Now let's be certain from the start that if you have problems concerning both at the same time, it will be difficult to get your loan approved even with strong compensating factors. So what we're talking about is either credit or income as a problem.

For example, let's say that your income isn't sufficient for the loan you are requesting. If you can show compensating factors, such as making a large down payment, or having significant cash reserves after closing, a lender may approve your loan anyway.

Credit issues are more difficult, and usually require several compensating factors to offset. The lender may even require that you add a cosigner to the loan to get approval. However, if you have compelling compensating factors, that may not be necessary.

How to develop your own compensating factors

If you are applying for a mortgage and concerned that there may be issues regarding either your income or your credit history, you should make an effort to identify any compensating factors that may exist in your profile.

The reason that this is a necessary step is that a compensating factor only matters if it can be documented. For example, if you have a lot of financial assets, you should be prepared to document these with statements proving their existence.

Another would be documenting additional income not used to qualify. For example, if you regularly work overtime, but haven't done so for at least two years, you should still document the additional income with paystubs and W2s. If you have a profitable side business, you should be prepared to provide a tax return showing the income. The lender can’t use it to qualify you for the loan, but they can use it to justify higher debt ratios.

And if you're in a position to do so, one of the strongest and easiest compensating factors is to increase the size of your down payment. It always increases the chance that your loan will be approved. For example, if you are prepared to make a 20% down payment, consider making a 30% down payment.

Your mortgage lender will work with you to develop compensating factors. But you can help your case by knowing what they are, and being prepared to document them in advance.

Start your mortgage approval now.

Our advise is based on experience in the mortgage industry and we are dedicated to helping you achieve your goal of owning a home. We may receive compensation from partner banks when you view mortgage rates listed on our website.