I did a search and read a couple threads on this, but would still be interested in knowing more about how to handle this. Our underwriters want to use residual income (whether specific amount or a %) as a compensating factor for an otherwise high DTI. I don't see anything on the face that smacks of fair lending as long as they document their file on why a high DTI was approved. Any other thoughts or disagreement on this? Would you find it better to use a specific amount in guidelines or a % of income as residual so as not to disadvantage the LMI st?

Can you define what you mean by residual income?

Residual income would be the income left over, at disposal of applicant, after all monthly debts are paid, including the new debt they are applying for. So looking at borrower making $10,000/month with debts totaling $5500 (so a DTI of 55%)--if they have the $4500 at disposal this is their residual income that could compensate for the high DTI. Residual is just the disposable income.

It is only fair to look at the residual or disposable income. While this is to an extream, why wouldn't it be fair to say the its descriminatory against wealthly people who have DTI over a "quaifying percentage" and still have many thousands of dollars left in "residual" income. It doesn't make sense to decline a loan when the customer has no problem repaying the loan.

I see no problem using residual income in a credit decision. Afterall, the agencies require banks to consider whether the borrower can repay the debt. So just because someone has a high DTI, that is just one underwriting factor to consider. So if someone hits the DTI ceiling, but has dispoable income at the end of the month to cover it, then it could be a good bank loan. Income is not a protected class, so as long as someone can afford the loan, give it to them. If the lower income persons hits the same DTI but has very little disposable income to cover the debt, then you don't make the loan. Use the income as a compensating factor and document the heck out of it, just in case.

Using residual income, or a cash flow analysis is simply an example of flexible underwriting. When flexible underwriting is done to help the applicant get the loan it is generally considered as a positive.

That being said, be sure that this kind of flexibility goes both ways. For example, you could have a fair lending problem if you provided this flexibility for high-end customers but did not look at budget management at the low end. Consumer advocates have long claimed that lenders who rely only on the ratios may deny applications from people who are skilled at and accustomed to handling tight budgets with high ratios.