What Are Lender Overlays?
Fannie Mae, Freddie Mac and the FHA/VA—otherwise known as government-sponsored enterprises (GSEs)—buy mortgages from lenders once the loans close. The GSEs all have specific requirements for the mortgages they buy, and so largely control what types of loans lenders will originate for the consumer.
However, lenders can add requirements for borrowers on top of what the GSEs allow, to protect themselves from risky loans. It is kind of like when people get cold more easily than others; they put on an extra layer. An ‘overlay,’ if you will.
What Can Trigger a Lender to Impose an Overlay?
There are several things that may cause a lender to become skittish. I’ve listed four of the most common reasons below:
1) Bad Credit
Even if the FHA says they accept credit scores as low as 500, many lenders will not. Some may require 580, 640 or or more—depending on their appetite for credit-score risk. So it’s important to shop around and compare. Experienced loan officers can help with this, as they will know of other lenders and their particular overlays.
2) High debt-to-income ratio (DTI)
Some lenders may not approve a loan if the borrower has a DTI over 43%. This, again, is in contrast with the FHA which currently says they accept loans with a DTI up to 56.9% (as long as the consumer also has a credit score of at least 620).
3) Shaky Job History
A borrower who has held the same job for awhile indicates financial stability and trustworthiness to the lender. If there are gaps in your resume, or if you’ve been a job hopper in recent years, it may trigger a lender overlay that makes it more difficult for your loan to be approved.
4) Short Credit History
A borrower who doesn’t have a lot of years as a credit holder may find it more difficult to procure a loan. Lenders want to borrowers to prove they are trustworthy when it comes to loan repayment, and if there is little to no proof, it could cause the loan to be rejected.