A lot of people think that qualifying for a mortgage is going to be the same from one bank or mortgage company to another. Most mortgages are placed according to the guidelines set by the big players in the mortgage industry, Fannie Mae and Freddie Mac, who buy up most of the conventional mortgages after they are originated, or FHA or VA guidelines for government loans. It is true that lenders all work through the same guidelines, but in reality, it’s not quite that simple. It is very common for a borrower to be denied a loan with one lender, and then be able to close on a loan for the same program with another. Why is this possible?
A big answer to that question, is overlays. Overlays are additional requirements set by each bank or mortgage lender, beyond the guidelines established. If you go back in time to 2007 or 2008, there was no such thing as an overlay. We would put the loan details into our mortgage software, and if it met the guidelines of the program (again, Fannie or Freddie or the government guidelines) the automated intelligence system in our software would give it an approval. As long as the details we put into the program matched up with the documentation, that was all we needed for the approval. But everything changed once the real estate market imploded, and property values started to drop. In the mortgage industry it is typical for one company to originate the mortgage (Work with the buyer up through the closing), and then sell the loan off to another bank or lender. They would then get paid, and have money available for future loans. When property values started going down, the risk increased for everyone. Loans that were looked at as safe when property values were rising, suddenly looked much more risky. Lenders were looking for extra assurances, and they began to change what was acceptable, going beyond the end lender guidelines and adding additional requirements of their own.
What this means, is that lenders will take the base guidelines, and add on their own requirements. Some of the more common overlays include:
- Minimum credit scores – This is a big one. For example, FHA will go down to a 500 credit score (with a larger down payment), but many lenders require a 620 or even a 640 score to be approved.
- Not allowing gift funds – Gifts are an acceptable source of funds, but this can allow a borrower to buy a home with little or no money out of their own pocket. Some lenders think this is a significant enough risk that they have it as an overlay, and require the borrower come up with some of the cash.
- Requiring additional reserves, or money left over after the closing.
- LTV or Loan to Value – this is requiring more equity in the home, or a higher down payment.
- Lower debt ratios – A common overlay is requiring less debt than the program guidelines will allow.
There are hundreds of possible overlays, and it is up to the individual bank or lender what is acceptable. The company I work with, loanDepot Mortgage, is one of the largest non-bank lenders in the country, and keeps the servicing (who you make your payments to) on most of it’s loans. This means it has a bigger pool to work with,and because of this we have virtually no overlays. This can be a big difference. We regularly approve and close loans that were denied by other lenders. If you’d like some more information on overlays, or talk more on your own specific situation, let me know.
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