What Are FHA Compensating Factors?

Written by Haley HarrisonUpdated: 20th Mar 2022
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FHA loans are an attractive option for borrowers who may struggle to qualify for conventional mortgages. With looser requirements and more flexibility, it could mean the difference between someone becoming a homeowner or not.

If you’re looking to get an FHA loanbut notice you fall beneath the minimum requirements in an area or two, FHA compensating factors can be one way to strengthen your loan application.

General FHA Guidelines

FHA loans were designed to help a broader range of borrowers secure financing and become homeowners. The guidelines for FHA loans are more flexible than other types of loans, but borrowers still need to meet certain standards. Generally, borrowers need to maintain a credit score of 500 and have less than a 36% debt-to-income ratio.

>> More: Best FHA Mortgage Lenders

What are Compensating Factors for FHA Loan Approval?

Although the requirements for FHA loans are already less stringent than other loans, you still might fall short in one or more categories. In this case, you can think about compensating factors.

FHA compensating factors are the stronger parts of your loan application that offset or compensate for the weaker areas. So, if you are struggling to meet the minimum credit score to get a mortgage, you can try to compensate by making a larger down payment or having larger cash reserves. This is all to show mortgage lenders that you are a reliable borrower who will make their monthly mortgage payments.

Here are the requirements you’ll need to know to qualify for an FHA loan. You can begin thinking of which areas you can use as the compensating factors for your FHA loan application.

Minimal Debt

Existing debts are a significant factor in qualifying for a loan. If you have your monthly income tied up with other debts to pay, you’re more of a risk to a mortgage lender. What you’ll need to look at is your debt-to-income ratio. You can plug your income, debts, and other expenses into this FHA calculator to see how much you could borrow.

The lower your DTI, the better. Lenders will look for a DTI lower than 36% to qualify you for a loan. If you can reduce your monthly payments as much as possible, you’ll be a more successful mortgage loan candidate.

Documented Cash Reserves

When lenders evaluate borrowers for a loan, they need to ensure that the person they’re lending to is low risk and will pay the loan back. One way they do this is by looking at your assets. They see what you have in savings as the backup plan if something happens to your monthly income. If you have funds set aside, you have a way to pay your mortgage, which will make you more attractive to lenders.

Cash reserves are not a requirement for FHA loans, but it is one compensation tool you can use to your benefit if you lack in another area of your application.

>> More: See FHA Appraisal Requirements

Residual Income

Residual income is what you have left in your pocket after you pay off your monthly expenses. What do you have left to pay your mortgage after paying off your monthly credit card statement, car payment, and other debts?

This is the question on your lender’s mind. The bigger the “cushion” between your expenses and monthly income, the better. They want to know that you’d still have funds to pay your mortgage if your income were to drop.

Consistent and Steady Employment

To get residual income, you need a steady paycheck. Showing lenders that you can maintain a job and a consistent flow of income are crucial factors to qualifying for a loan.

If your job history is all over the place, it can make you seem like more of a risk. Consistency is important, and they want to know you have the stability to make a monthly mortgage payment.

Outside Income

On top of your monthly salary, any other income is icing on the cake. This can be overtime, seasonal work, bonuses, or even a side-hustle. The more cash you have coming in the bank each month, the better. This is one of the more accessible ways to compensate for other application areas. It’s a lot easier to get some part-time work than increase your credit score in the short term.

Your Credit History and Score Still Matter

Even though there are ways to offset a less than perfect credit score, your score still matters. The higher the credit score, the better the interest rate.

Your credit history is a way to show lenders that you are a reliable borrower and that you have a track record of paying your bills. If you have any unpaid dues in your credit history, it’s in your best interest to get them taken care of ahead of time.

>> More:How Does a Mortgage Affect Your Credit Score?

Always Make a Down Payment

The minimum required down payment for FHA loans is only 3.5% of the purchase price, and one of the many advantages of going with an FHA loan.

If you’re able to put down more, it’s better to do so. Not only does this increase the equity you have in your home, but it’s one more tick in the “good borrower” column. Online mortgage lenders look at it this way: The more this person has invested in the home, the less likely they will default on payments.

Bottom Line: FHA Compensating Factors

Just because a borrower fails to meet all the requirements for an FHA loan does not mean it’s time to throw in the towel. Borrowers can make up for weaker parts of their application by strengthening other elements. If you have a lower credit score or higher debt, there are still ways you could qualify for FHA loans through other compensating factors.

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Haley Harrison
Haley Harrison

Haley is an experienced writer and has worked for several years on the title side of the real estate world. Through her work, she helps educate homebuyers on the ways they can prepare for homeownership. When she is not writing or getting buyers and sellers to the closing table, Haley enjoys travelling, studying personal finance, and being at home with her dog. She attended the University of Cincinnati majoring in International Relations, and holds a M.A. in Bilingual Education from Universidad de Alcalá. Haley’s areas of expertise spans mortgages, real estate, and loans.