When you apply for a certain mortgage program, you expect to get the same answers from every lender. However, that’s not always the case. The same mortgage program can have different underwriting guidelines from lender to lender.
It’s called lender overlays. Lenders are able to add guidelines to what the loan program requires. However, they cannot ever take away from the minimum guidelines. It’s the lender’s way of being able to lower the risk of default by only take loans that they feel are a good risk.
The Different Types of Overlays
It’s likely you will come across a variety of different overlays as you shop for a mortgage. The most common are:
- Credit score overlays – Requiring a higher credit score than the program allows. For example, the FHA allows credit scores as low as 580, but many lenders don’t allow that. They want higher scores to reduce the risk of default.
- Loan-to-value overlays – Some lenders may restrict the amount you can borrow to an amount that is less than the program allows. For example, FHA loans allow an LTV of 97.5%, but some lenders may require a 5% down payment just to help you have a little more skin in the game.
- Maximum debt-to-income ratio overlays – You may find lenders that tighten up the restrictions on the debt-to-income ratios. They may not like the loose guidelines the program has, such as the VA’s maximum 43% debt ratio. If a lender is worried about your risk of default, they may require a lower DTI.
Why Lenders Have Different Underwriting Guidelines
When you take out a loan, you take it out with the lender, not the entity guaranteeing or buying the loan. In other words, you don’t borrow the money from the FHA or Fannie Mae. Instead, you borrow it from the bank. This means the bank is at the forefront of the risk. If you don’t make your payments, the bank is out a lot of money. In some cases, there may be a slight guarantee from the government agency, such as the FHA or VA. But, the bank still loses out on the deal.
Each lender has their own threshold for risk. Some lenders have larger portfolios and more capital. They can take on the loans with a little risk and won’t go under if the borrower defaults. Other, smaller banks don’t have that flexibility. They have to have tight restrictions in order to make sure that they don’t take on a loan that could end up in default.
Shopping for the Right Lender
So should you be scared of a lender with overlays? It’s not the end of the world, that’s for sure. But, it could make it harder for you to get a loan. So what can you do about it? Shop around. You could shop with five different lenders and find five different requirements for the same loan program. If you have special circumstances that preclude you from getting a loan with certain lenders, just keep trying. As long as you meet the basic requirements of the loan program, such as FHA, VA, or conventional, you will find a lender.
There’s another benefit of shopping around as well – you’ll find the lowest rates and fees. Just like lenders can add their own rules, they can charge their own rates. You may find lenders that add to the basic rate if you don’t meet their stricter requirements. Shopping around will help you compare rates and fees, understanding just what type of loan you can get.