Key Takeaways
- Lender overlays may require higher credit scores than program guidelines.
- Different lenders have unique overlays, so compare options carefully.
- Shopping around can help you find a lender with fewer overlays.
- Overlays might mean larger down payments than minimum program requirements.
Article Summary
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.
Lender Overlays: Explained in Plain English
A lender overlay is simply an extra rule a mortgage lender adds on top of the official mortgage guidelines. Overlays are not part of the loan programs themselves such as FHA, VA, or conventional mortgages. They are additional requirements that a lender applies to its mortgage approval standards.
Overlays lower a lender's risk. For example, FHA guidelines allow credit scores down to 500, but a lender might set their minimum FHA FICO score to 580. Another lender may require a credit score of 620.
Because overlays are unique to each lender, the same mortgage application could be denied at one lender but approved at another. This is why shopping lenders is so important, especially for first-time home buyers and buyers whose applications were initially turned down.
If at first you're not approved, try another lender.
Examples of Lender Overlays
Conventional Mortgage
- Guideline: A signed job offer letter can count as proof of income
- Overlay: Some lenders require an actual paycheck instead
FHA Mortgage
- Guideline: FHA allows approval with credit scores as low as 500
- Overlay: Some lenders require at least 580
VA Mortgage
- Guideline: VA loans don’t have a minimum credit score requirement
- Overlay: Some lenders set their own floor, such as 620
Common Lender Overlays Table
| Overlay Type | Sample Mortgage Guideline | Typical Lender Overlay |
|---|---|---|
| Credit Score | 500 Minimum | 620 minimum |
| DTI Ratio | Up to 57% DTI | Up to 43% DTI |
| Job History | Job gaps allowed | No job gaps allowed |
| Income Proof | Offer letter or pay stub | 30 days of pay stubs, 2 years W-2s |
| Collections | Small collections ignored | All collections paid off |
| Bankruptcy Wait | 4 years | Longer wait required |
| Properties Financed | Up to 10 properties financed | No more than 4 properties financed |
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
Get answers to frequently asked questions about lender overlays, including why they exist, how they vary between lenders, and how to prepare for them.
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.
