What Are Mortgage Overlays?

What Is a Mortgage Overlay?

Mortgage overlays are qualification standards a lender adds on top of official mortgage guidelines. Also called lender overlays, they can be applied to Fannie Mae and Freddie Mac conventional loans as well as government-backed mortgage loans including Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) and Department of Veterans Affairs (VA) loans.

For instance, lenders can require borrowers to provide a larger down payment or maintain a higher credit score than what the official mortgage rules say. The extra requirements lower the lender's risk because if the borrower can meet the added overlay, they have less likelihood of defaulting.

Mortgage overlays are sometimes prompted by unstable market conditions that increase the lender's risk. They can also result from red flags in your financial profile, the property type or the loan type you're considering.

Types of Mortgage Overlays

You may need to deal with a mortgage overlay if your lender increases their eligibility standards above the official requirements. Generally, you'll know about the overlay when applying for a home loan. Here are some areas where common mortgage overlays could affect you:

• Debt-to-income ratio (DTI): Each mortgage program has a preferred DTI ratio, which shows how much of your gross monthly income goes toward debt payments. Lenders generally prefer a DTI of 43% or less, but some require a lower DTI than that.
• Credit score: Among the major mortgage programs, only FHA loans have a stated minimum credit score, which is either 500 or 580 depending on your down payment. Lenders may raise their minimum credit score criteria.
• Credit history: In addition to checking your credit score, lenders may review your credit report for details like the number of accounts you've handled and for how long. They may use this information to help determine whether you qualify.
• Employment history: Applicants with minimal or shaky employment histories may not qualify for a home loan even if they meet other requirements.
• Property type: Some lenders limit the types of property you can buy with one of their home loans.
• Bankruptcy: Consumers with discharged bankruptcies can qualify for home loans per federal guidelines. However, most lenders have overlays that require a waiting period of one to four years.
• Down payments: Some conventional mortgages allow you to put down as little as 3% and use gift funds for the down payment. But lenders may set higher standards—such as a 5% or 10% down payment—and can restrict the use of gift funds.
• Cash reserves: Federal mortgage guidelines generally require a few months of reserves to qualify for a home loan, but some lenders won't approve borrowers with less than six months' worth of mortgage payments stashed away.
• Collections and charge-offs: FHA guidelines do not require collections and charge-offs to be paid in full to qualify for a home loan, but some lenders have overlays that prevent applicants with unsettled or unpaid delinquent accounts from qualifying.

Can You Avoid Mortgage Overlays?

You may be able to avoid overlays by shopping around with different mortgage lenders. Ask about their minimum eligibility requirements, or request a prequalification to get a feel for whether the lender is a good fit. Some lenders don't have overlays that would disqualify you from borrowing, or your financial profile may be strong enough to avoid them with other lenders.

If you find a lender you like, they may be willing to remove certain overlays in exchange for a higher interest rate or larger down payment.

Still no luck? Consider returning to the drawing board to improve your credit and overall financial health before trying again at a later date.

Compare mortgage rates

Check today’s rates to find the best loan offers. Staying updated on current rates helps you secure a competitive mortgage and save more over time.

How to Prepare Your Credit for a Mortgage

Preparing your credit can help you qualify for a home loan and potentially receive competitive rates. Consider taking these steps a few months before applying, since credit improvement can take time.

1. Review your credit reports and scores. This helps you figure out where you stand and where you may need to improve. You can get copies of your credit reports for free from all three credit bureaus (Experian, TransUnion and Equifax) at AnnualCreditReport.com. You can also get your Experian credit report and FICO^® Score^Θ for free anytime. Note areas that need improvement. If you spot information you believe to be incorrect or outdated, promptly contact the appropriate creditor. You also have the right to file a dispute with the credit bureaus on whose reports the information appears.
2. Pay all your bills on time. Payment history is the most important factor influencing your credit score. Focus on making timely payments so lenders can view you as a responsible borrower.
3. Get current on past-due debts. Pay off collection accounts and charge-offs if possible, since it could be tougher to get a mortgage if these accounts remain unpaid.
4. Lower your credit card balances. The lower your credit utilization on credit cards, the better, but aim to keep your credit usage below 30%. Keeping balances low can have a positive effect on your credit.
5. Don't apply for new credit. Consider avoiding new credit applications if you're planning to apply for a mortgage in the near future. Each new application creates a hard inquiry on your credit report, which could temporarily lower your score by a few points. Lenders could also become concerned if you're applying for a lot of new credit before taking on a mortgage.

Tip: If you've recently been denied a mortgage, reach out to the lender to learn why your application wasn't approved. The loan officer may be able to provide insights to help you resolve any issues causing mortgage overlays to be applied to your file.

The Bottom Line

Researching mortgage lenders before submitting loan applications can help you find banks whose qualifications you can meet. If necessary, take time to improve your credit or save more for a down payment to help your chances of approval. Take the first steps by getting your FICO^® Score for free to help you see where you stand.