The VA issues loan guidelines, some of which are required and some which the lender may have to use its own judgment when determining whether or not the loan meets the requirements. For example, VA rules require that the appraisal be at least the same amount as the sales price of a home. The lender can’t do much about that. On the other hand, the VA requires that lenders make sure the veteran has used credit responsibly. The lender has some leeway about that and usually this is done by establishing a minimum credit score which can vary from lender to lender. Some VA lenders may even approve a loan using alternative credit sources such as utility bills while other VA lenders shy away from the practice.
But what the VA does not do is approve the loan. The loan approval is issued through an approved VA lender whose job it is to make sure the VA loan applied for matches what the VA requests. This leaves some wiggle room for VA lenders when a judgment call must be made. Not much mind you, but some.
The space required for some wiggle room isn’t as wide as it used to be as lenders may be forced to buy back a loan that didn’t meet VA guidelines after all, as determined by the lender who purchased the loan or even Ginnie Mae. Lenders aren’t as inclined to approve a loan that just squeaks by as much as they used to. In some lender’s minds, it’s better to decline the loan than worry whether or not the loan meets all the required VA rules. When a lender does decide to approve a loan when the approval is solely up to the VA lender, the lender looks for other things in the file that would justify issuing a VA loan approval. These are called compensating factors.
What Are Compensating Factors?
A compensating factor is something in the loan file that balances out something in the file that may be somewhat marginal. For example, say that a debt to income ratio is a little on the high side and the lender must make the determination whether or not to go ahead and issue a final approval. There are some things that a lender cannot override such as poor credit but most often compensating factors are applied when debt ratios are higher than what the VA requires.
For example, say that a borrower’s debt to income ratios are right at 48 while the VA requirement is 41. Lenders have the ability to go ahead and issue an approval if there are compensating factors that will more than offset the high ratios. Common compensating factors are:
Excellent Credit– While the VA does not set a minimum credit score most VA lenders do and the minimum most often applied is 620. Scores below 620 will usually be declined. If someone has a high debt ratio however and the credit score is say 790 then the VA lender can make the decision to go ahead and approve the loan due to excellent credit. Debt ratios may be high but the borrower has previously demonstrated the ability to handle debt responsibly.
Liquid Assets– Lots of cash in the bank after the loan has closed is another example of a strong compensating factor. A veteran who has shown the ability to save money every month instead of spending it.
Very Low Ratios– Sometimes debt ratios can be used as a compensating factor when other issues seem to muddy a loan file. For example, if a lender decides to override an automated approval and approved the loan manually, the reason for the decision could be low debt ratios. If the VA maximum debt ratio is 41 and the veteran’s debt ratio is say 15, that’s a very good reason to go ahead and issue an approval.
Know In Advance
If you’re not sure if your loan will be approved, your loan officer should be able to help. If your loan application is submitted to an automated underwriting system and is not approved, your loan officer should be able to speak to their underwriter and ask if the loan may be eligible for an approval after all based upon positive compensating factors in your file. The underwriter won’t be able to say “yes” or “no” without reviewing the entire package, but you can get an indication of the likelihood of an approval without having to go through the entire process.
Instead, your loan officer will likely say something to the effect of, “I think we can get this through but nothing is 100 percent until the file is completely documented.” You never know in advance but you can get a pretty good idea. And hey, you know what the result will be if you decide not to apply at all, right?