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Get a Mortgage Loan with Bad Credit: Watch Out For Lender Overlays


Did you do some research on your own to find out what the minimum credit score might be for an FHA loan? Or any other type of mortgage for that matter?The issue is lender overlay. You can find information about pretty much everything online these days. The challenge is to determine whether the information is valid or not. It used to be that if a story was printed in the newspaper most would feel confident the information was true. Yet in today’s online environment if the source of the information is unknown it may not be reliable. This is true as it relates to mortgage lending as well.

For instance, say a couple does realize they have damaged credit but are looking to finance a home and get their credit scores back on track. So, they do a little digging and see the FHA has a minimum credit score requirement of only 500 with a down payment greater than the standard 3.5 percent, something considered “poor” by FICO score standards. So they apply for a mortgage and their credit scores are pulled and one has a representative score of 550 and the other 540. The lender informs them their request for an FHA loan cannot be approved. Why not? What happened? The FHA guidelines only need a 500 score and their scores are higher than that.

The Issue is a Lender Overlays

An overlay is additional layer of approval that a lender can impose on a mortgage. Using this example the lender may require a minimum credit score of say 620 in order to be approved for an FHA loan. This is perfectly legitimate and certainly the lender’s prerogative. A lender can apply an overlay any time it wants as long as the new requirement is applied universally. A lender isn’t allowed to require a 580 score to one borrower and a 640 for another under the exact same circumstances and loan type. That’s discrimination and the lender could be not only fined but sued and potentially put out of business for such an extended pattern of egregious behavior.

lender overlay

Why Lenders Use Them

Lenders can apply an overlay in order to strengthen the quality of the loans they sell. For example, let’s say a lender’s default rate is climbing and suddenly there are fewer buyers of the loans it approves. Fewer places to sell means lower profits on each loan sold. So, the lender decides to change that performance and for all conventional loans with a down payment of 5.00 percent the minimum credit score has to be 680 and with a 10.00 percent down payment the score must be 660.

This will of course, reduce the number of the loan applications it receives and loan officers that work there might grumble for a while and complain the lender is placing too great a restriction on its loan programs. However, over time the quality of loans they approve improve significantly and default rates begin to fault. Soon, the lender is known for selling loans that will perform as advertised and will not go into default.

Lender overlays can be more than just massaging credit scores. Lenders can require more down payment for a certain loan or allow debt to income ratios reach only certain levels. Whatever the lender decides to apply the lender can as long as the move doesn’t appear to be discriminatory against any protected class and that all applicants are subject to the same overlay and cannot be waived without cause.

Putting this in practice, overlays mean one lender might decline a loan application while another might approve that very same loan under the very same set of circumstances. That’s why it’s important for borrowers to understand that just because a loan did not get an approval at Lender A it might get one at Lender B.

Experienced loan officers know in advance, or at least they should if a loan application will receive an approval simply by reviewing the loan application, documentation, and credit. Experienced loan officers are also aware of various lender overlays when selling to one mortgage company compared to another. As long as the loan meets the minimum guidelines a loan can be approved but if an overlay is added to the minimum standards the loan may not qualify, even though it meets the minimum standards.

When a mortgage company states there are no overlays on a particular loan program it means there are no additional restrictions for that loan other than previously established standards there won’t be any “gotchas” during the approval process.

Note that overlays make it more difficult to qualify for a loan and lenders are not allowed to ignore or remove a qualifying guideline without running into the possibility of approving a mortgage loan that no one will buy or selling a loan only having to buy it back because it didn’t meet minimum standards.