If there’s one thing that can get in your way when you are trying to get approved for a mortgage, it’s lender overlays. These rules go above and beyond what specific mortgage programs require. For example, FHA loans allow credit scores as low as 580. Some lenders may not be comfortable with a score that low, though, so they may increase the minimum credit score requirement for the program.
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This is just one example of what lenders can do. As long as they abide by the minimum rules set by the program, they can add any requirements they wish to them. This could make it difficult to get approved for a mortgage.
Keep reading to learn how you can maximize your chances of approval.
What are Lender Overlays?
First, let’s look at the most common lender overlays so you know what you might be up against.
- Credit score – This is the most common, as we discussed above. Your credit score is a look into your financial responsibility. If you don’t have a good financial history, why would a lender want to lend you money? If you have a credit score that ‘just meets’ the program’s requirements, you may have a tougher time finding a lender.
- Debt ratio – Your debt ratio shows lenders how much of your monthly income that is already used. Each program has a maximum front-end (housing) ratio and back-end (total) debt ratio. Lenders oftentimes lower the maximum allowed to protect themselves.
- LTV – Many loan programs allow low down payments; some even allow no down payment. This puts the lender funding the loan at risk, though. If you have other ‘high risk’ factors, it’s not unusual for a lender to require a higher down payment than the program requires.
Getting Around Lender Overlays
If you have one or more qualifying factors that just meet the program requirements, you may find yourself subjected to lender overlays. You can get around it though. You need compensating factors.
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This means you shouldn’t apply for a loan if your credit score is the program’s minimum, your debt ratio is at the max, and you only put the minimum down payment on the home. This is too risky for a lender. You need to ‘make up’ for the negative factors on your loan.
For example, let’s say you have a 580 credit score and apply for an FHA program. That’s the program’s minimum allowed score. The FHA loan also allows for 31/43 debt ratios and a 3.5% down payment. If you want to work around the lender overlays regarding the credit score, assuming you find a lender that wants a 620 minimum score, you can show a low debt ratio and/or high down payment. For example, if you show the lender that you are willing to put 10% down on the home, they may overlook your lower credit score. Maybe you don’t have that kind of money to put down, but you have a low debt ratio of 28/36 even with the new mortgage. That could also be another compensating factor.
Basically, you need to give a lender a reason to trust you despite one negative factor. We recommend that you keep your negative factors at one. Like we stated above, the combination of a low credit score and high debt ratio could be too much for a lender to accept.
Once you figure out your credit, debt ratio, and down payment situation, it’s time to shop for a lender. This may take some time, so be prepared.
At a minimum, you’ll apply with 3 lenders. It may take more than that though. Don’t get discouraged. There are hundreds or thousands of lenders out there, many of which are approved nationally. They can provide you with the financing you need. Not every lender you come across will have requirements that are much stricter than what the mortgage program requires.
You can save yourself some time by talking with the lender upfront. Before you apply, let them know of your situation. If you’ve already been turned down by one lender, you know your circumstances. You know why they declined your loan. Let other lenders know where you stand. Talk about your credit score, debt ratio, and required LTV. The loan officer will let you know where you stand and let you know if applying with them is worth your time and effort.
Lender overlays may seem harsh and as a way to keep you from getting approved, but they truly protect you and the lender. They make sure you don’t take a loan you cannot comfortably afford. They also help protect the lender from default. Using the overlays to your advantage may help you perfect your qualifying factors so that a mortgage is as affordable as possible for you.
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