Portland Example: First Time Homebuyer Income Required to Qualify for a FHA Oregon Bond Loan Could Be Reduced by Up to 22% Using FHA Compensating Factors.

There are a wide variety of measures that are used to determine homeownership affordability. Those measures can include down payment assumptions, loan rate assumptions, home price assumptions, and allowable debt to income ratio assumptions. 

However I don't recall seeing any projections of the income required to purchase a home that use compensating factors as part of the debt to income analysis. Compensating factors allow applicants to qualify for larger loans than they would qualify for using standard housing debt and total debt to income ratios of 31% for housing expenses and 43% for all reoccurring expenses.

I'm most familiar with FHA lending so my examples will focus on FHA compensating factors. but  I'm sure that other loan programs also have their versions of compensating factors. 

Pre COVID 2019 HMDA Data Shows That the MAJORITY of Oregon FHA Home Purchase Borrowers Had Debt to Income Ratios of 44% or Higher.

In Oregon my review of 2019 HMDA data shows that 52% of FHA home purchase first lien loans originated had debt to income ratios of 44% or higher. (4,404 FHA home purchase first lien loans where DTI was reported at 44% or higher/7,922 total FHA first lien home purchase loans where DTI was known=52%). 

I also looked at Oregon 2019 HMDA data for FHA first lien home purchase loan originations to Hispanic, Black, and Asian borrowers. Their share of FHA first lien home purchase loans originated where DTI was 44% or higher was 66%, 67%, and 67% respectively.

[The link HERE will download the 2019 HMDA Oregon data for your review and further analysis]. 

FHA Compensating Factor Guidance

FHA's Single Family Policy Handbook 4000.1 includes a matrix of manual underwriting compensating factors that can be used to increase the percentage of income that can be used to qualify for an FHA loan.

The table pasted below (from handbook printed page 335) lists those factors that can be used to increase the amount of income used to qualify an applicant for an FHA loan:

A Portland  First Time Homebuyer Metro Example. 

I took the information from that table and applied it to an example I created for the Portland metro area for first time homebuyers. The PDF table I created is HERE and embedded below.

For the Portland metro area I created four scenarios shown in the PDF; a description of the compensating factors required for each scenario at at the top of each column:  

1. All scenarios assume a credit rating of 580 or more. This is, by itself, a compensating factor.
2. All use the current OHCS non targeted area Portland metro maximum purchase price of $453,000, the 2.25% current "cash advantage" interest rate for the Oregon Bond program, and a 3.5%/$15,855 down payment. All scenarios are fixed rate 30 year loans. Note that these terms are generally available only to first time home buyers. There are some exceptions for veterans and also for purchasers of property in targeted areas.  
3. The one time 1.75%/$7,650 FHA upfront mortgage insurance premium is included in the amount financed and the monthly MIP expense is .85%/$310.
4. Monthly property taxes and insurance and homeowners association expenses are estimated at 1.3%  of the purchase price divided by 12. ($491 per month).
5. Total monthly housing expense is $2,387.
6. Monthly non-housing reoccurring debt is assumed at $300 per month except for the 4th scenario where it is zero.
7. None of the scenarios factor in any boost for energy efficient homes, which could add 2% to the front and back ratios. My read is that these factors may only be available for scenarios 1 and 2.

Observations:

1. Using standard FHA underwriting ratios of 31%/43% in the first scenario the applicant would need $96,800 in annual income.
2. Scenario 2 requires only one compensating factor out of three possibilities and would decrease required income to $81,200 and increase allowable underwriting ratios to 37%/47%.
3. In scenario 3 there is an $75,100 income requirement but the applicant must meet at least two of these three compensating factors. The $75,100 income requirement is 22%/$21,700 less than in the first standard scenario. The underwriting ratios for this scenario are further increased to 40%/50%.
4. In scenario 4 (with only ONE required factor--no monthly recurring debt) the annual income required is also $75,100. using underwriting ratios of 40%/40%.
5. Using HUD's 4 person MFI for the Portland metro area of $96,900, 

Scenario 1 requires an income of $96,800---100% of MFI, 
Scenario 2 requires an income of $81,200--84% of HUD MFI, and 
Scenarios 3 and 4 require an income of $75,100--78% of HUD MFI.

NOTE: Use of a higher down payment would reduce monthly housing costs and reduce the income required to qualify in all scenarios, but poses a challenge for first time home buyers since it would also increase the cash required to close the loan.

Caveats:

1. The guidance cited above applies to manual loan underwriting. I do not know the extent to which these specific factors are modified or incorporated in the automated underwriting systems.  However given the large share of loans with DTI of 44% and higher it seems highly like that FHA approved automated credit scoring systems DO use credit scores and other factors in issuing loan approval decisions for loans with DTI at 44% and above. 
2. Lenders are free to adopt more restrictive standards than found in the handbook.  
3. I used the more restrictive income income limit of the two limits in each scenario rounded up to the next higher $100. 
4. The documentation required for each compensating factor can be found starting on PDF page 351 of the 40001.1 handbook.  
5. I used the latest version of the handbook, which is effective in August; I don't see any substantive changes in the compensating factors from those used in the current Handbook.

Originally created and posted on the Oregon Housing Blog.