Mortgage qualifying is a balance and interplay between a number of basic fundamental qualifying factors and numerous other major/minor lesser or "compensating factors". Qualifying factors are the main criteria used by almost all lenders to determine the riskiness of a particular borrower. Compensating factors are items underwriters review when borrowers are weak in another major qualifying area. The following is a very general overview of the 4 main basic mortgage qualifying factors and how they relate to one another and are influenced by other "compensating" factors.

1. Credit - Credit is based on a scoring model developed by Fair Isaac & Company called your FICO score. FICO scores can range from 350 to 850 with a 620 FICO typically being the cutoff for A/A- credit. If a borrower's score starts to drop below 620 his or her rate will be significantly affected. Anything below 620 is considered subprime territory. Ideally a borrower should try to keep their FICO above 680 to insure they are getting the best rate and to be able to qualify for Stated Income or Lite Doc programs (If they are not Full Doc borrowers). There are three main credit reporting bureaus, Equifax, Experian, and Transunion that collect credit information on you as an individual. Mortgage companies run a trimerged report which means they get information from all three bureaus and three FICO scores are computed. Most lenders will use the middle score unless their is a wide (usually more than 30 points) gap between them. Not all credit card companies report all of your information to all three bureaus. That is one of the main reasons why their can be a difference in scores and why& lenders will run a three bureau to get a full picture. Your FICO score will be negatively affected if you have many late payments, high balances and a short credit history along with more obvious derogatories such as judgements, bankruptcies, etc. There is also a possiblity of their being erroneous information on your credit report. It is best to check your credit ahead of time by going online and ordering a report. You can then dispute any erroneous information you find. Myfico.com is a good site to go too if you want to check your credit before you apply. They can give you an in depth understanding of the positives and negatives affecting your credit report and an idea of steps you can take to correct it. We have posted a credit scoring booklet from Myfico.com here so you can get to it immediately. Read it thoroughly. Your Fico score can greatly affect the type of loan you qualify for.

2. Income - Mortgage companies use formulas called debt to income (DTI) ratios to see if you have sufficient income to qualify for a mortgage. The simplest is called a front and back end ratio, example: 28/36 - 28 is the front end ratio and is the percentage of your gross monthly income you can use for you housing payment. Example: 28% of 5000 is 1400. 1400 would be the amount you can spend on your housing payment. Your housing payment is defined as your mortgage payment plus monthly property taxes and hazard insurance and homeownership association dues if any (maintenance fees if the property is a condo or a co-op)

36 is the back end ratio and is used to calculate the total amount of debt, your credit cards, auto, student loans, etc plus your housing payment, that you are allowed to have. Example: 36% of 5000 a month is 1800. You are allowed a maximum of 1400 for your housing (the front end ratio of 28 sets the cap) and an additional 400 dollars a month in other credit payments. If you happen to have 800 in other monthly payments, you will lower the amount of money you have to qualify for your housing payment down to 1000. The bank end number is the sum total of all debt allowed.

28/36 is a low ratio and is typically what you should have to get the very best rate. Depending on other factors such as the amount you put down, your credit, and the cash reserves you have after closing your ratio can go much higher. 36/40 is normally the highest you can go and still keep a very good rate. Once your back end ratio goes over 40 to 42% your rate will most likely start to climb. Typically you cannot go beyond 55% however in some rare cases, back end ratios have exceeded 65% (usually with a very large down payment or other strong compensating factors such as a great deal of extra cash reserves in the bank)

3. Loan to Value (Size Of Down Payment - The amount of money you put down determines your loan to value. Example:

20% down on a $100,000 house equals 80% LTV or Loan to value. The more you put down the easier qualifying becomes. Smaller down payment loan programs typically require better credit (FHA being an exception) and lower DTI ratios. A larger down payment can make up for deficiencies in credit or probelms in other areas such as Income.

4.Cash reserves - Depending on the loan program you usually need from 2 to 6 months of reserves after closing left to qualify (possibly more with superjumbos, loans over 1 million). Anything beyond 2 to 6 months becomes a compensating factor in case you are weak in another area, credit, LTV, or income.

Compensating factors - compensating factors are areas which underwriters look at in case one of the above, credit, down payment, income or cash reserves is weaker than it should be.

Examples of Compensating Factors:

Job stability or length of employment - Someone working in the same profession and or company for the past 10, 20 or 30 years is typically viewed as more stable than someone who has switched employment or professions 5 or 6 times in the last 10 years. Exceptions are possible if their is a rationale for job changes, promotions, changes due to more education, etc.  

Demonstrated ability to save - Some making $50,000 a year who is able to save a 500 dollars or more a month is viewed more positively than someone making 100,000 a year and spends it all and has a large amount of credit card debt.

Excess reserves - Cash in the bank after closing that is beyond the amount you need to qualify is a strong compensating factor that can make up for a weakness in credit, income, etc. Most lend programs require 3 to 6 monthly mortgage payments left over after closing to qualify for a mortgage. A borrower with 12 or 24 mortgage payments in the bank post closing we have a much easier time qualifying if they are weak in another area, such as a higher DTI ratio.

Underwriters (individuals who actually approve your loan) look at many different variables to approve a file and make a decision based on the whole picture and how flexible or stringent the guidelines are on particular loan programs.