Lender overlays are additional qualification standards that lenders impose on home buyers. These standards are in addition to the minimums established by the official mortgage guidelines.

A Longer Definition: Lender Overlays

Lender overlays are a lender's additional underwriting requirements that are not part of a mortgage program's official mortgage guidelines.

Lender overlays, sometimes referred to as investor overlays, are applied at the discretion of a mortgage lender. They can vary between loan types. Some lenders use them extensively, while others may not use them at all.

Lender overlays are designed to reduce a lender's risk and may include stricter approval standards. These can relate to credit score, debt-to-income ratios, and documentation requirements. Home buyers must meet a lender's overlays to get their mortgage approved.

Examples of Common Mortgage Overlays

Conventional Mortgage

• Official guideline: Home buyers can use a signed job offer letter as proof of income
• Lender overlay: Home buyers must receive a paycheck as proof of income

FHA Mortgage

• Official guideline: Home buyers with a 500 FICO score can be FHA-approved
• Lender overlay: All home buyers must have a 580 FICO score to be FHA-approved

VA Mortgage

• Official guideline: A credit score is not required to get a VA mortgage approved
• Lender overlay: A minimum 620 FICO score is required to get a VA mortgage approved

Because lender overlays vary between lenders, it is common for first-time home buyers to have their mortgage application declined by one lender, then approved by another without any changes to their application.

Lender Overlays: A Real World Example

Imagine a first-time home buyer with a 610 credit score applying for an FHA-backed mortgage at their local credit union. They submit their application, supporting paperwork, and sign the required documentation. However, the credit union denies the mortgage application because of the buyer's credit score.

The home buyer knows that FHA mortgages allow credit scores of 500 or higher. The buyer calls the credit union, which explains that they apply a lender overlay on credit scores, only approving FHA loans for buyers with FICOs of 640 or higher.

Not discouraged, the home buyer finds a different mortgage lender that follows the FHA's official guidelines and gets their mortgage approved.

Common Questions About Lender Overlays

Why do lenders have overlays?

Lenders use overlays to reduce their risk. By setting higher standards than the federal minimum guidelines, lenders add an extra layer of security against default.

Do lender overlays vary widely between lenders?

Yes, there is significant variation. Some lenders may closely follow federal guidelines, while others set much stricter standards.

How do lender overlays affect first-time home buyers?

For first-time home buyers, lender overlays can create additional challenges. Buyers may need to shop around to find a lender whose overlays are more suited to their financial situation.

Can I negotiate lender overlays?

Lender overlays are generally non-negotiable, as they are part of the lender's risk management policies. It is more about finding the right lender for your financial profile.

How can I prepare for lender overlays?

The best preparation is to strengthen your financial profile with good credit, stable income, and a manageable debt-to-income ratio. Additionally, research various lenders to understand their specific overlays.