What is a Mortgage Lender Overlay?
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What is a Mortgage Lender Overlay?

Michael Jensen, Mortgage and Finance Guru
, Mortgage and Finance Guru
Edited by Harry Jensen

What is a Mortgage Lender Overlay?

A mortgage lender overlay is qualification requirement applied by a lender that exceeds the standard qualification guidelines for a loan program. Borrowers should think of lender overlays as an extra layer of guidelines they must meet to qualify for a mortgage.  In short, applying overlays means that lenders use tougher borrower qualification requirements than they are required to according to general mortgage industry guidelines.

How Does a Mortgage Lender Overlay Work?

In many cases, lenders offer mortgage programs that are developed by other organizations. For example, many lenders offer the FHA, VA and USDA low or no down payment mortgage programs which are developed and backed by government agencies. These government agencies -- the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) -- are responsible for determining the borrower qualification and eligibility requirements for these mortgage programs. Program qualification and eligibility requirements include minimum borrower credit score, maximum debt-to-income ratio, down payment required, income and loan limits as well as other factors. If lenders want to offer these government-backed mortgage programs the borrower must meet the qualification requirements outlined by the government agency that administers the program.

Qualification and eligibility requirements also apply to mortgage programs not backed by the government, which are called conventional mortgages. The qualification guidelines for conventional mortgages are developed by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that develop mortgage programs and provide funding to lenders. In short, Fannie Mae and Freddie Mac buy mortgages from lenders which allows lenders to offer more loans to borrowers. Fannie Mae and Freddie Mac establish borrower qualification guidelines for the mortgages they buy. If an applicant does not meet the qualification requirements then Fannie Mae or Freddie Mac do not buy the mortgage from the lender. Because lenders usually want to sell their loans, they typically adhere to the requirements set by Fannie Mae or Freddie Mac.

In addition to using the qualification requirements established by the government agencies or GSEs, lenders develop their own internal mortgage qualification policies, also called lender underwriting, and this is where lender overlays come into play. In some cases lenders use qualification requirements for their internal underwriting process that are tougher than the guidelines established by the government agencies or GSEs.

These additional, more demanding requirements are lender overlays. For example, Fannie Mae may require a minimum borrower credit score of 620 for a certain mortgage program but a lender uses a minimum score of 680 instead which means borrowers with lower credit scores may not be able to qualify for the mortgage program. Or a mortgage program may allow a maximum debt-to-income ratio of 50% but a lender applies a debt-to-income ratio limit of only 43% which means borrowers qualify for a lower mortgage amount. In some cases lender overlays require borrowers to select a fixed rate mortgage and prevent them from selecting an adjustable rate mortgage (ARM), which offers a lower initial interest rate and monthly payment.  Borrowers who are familiar with qualification guidelines for a specific loan program may be surprised and disappointed if they cannot qualify for the program or other type of mortgage due to lender overlays.

Another example of lender overlays pertains to streamline refinance programs.  The FHA, VA and USDA all offer streamline refinance programs that enable you to refinance your existing FHA, VA or USDA mortgage without a property appraisal or credit score.  In many cases, however, lenders require appraisal and credit reports to satisfy their internal underwriting guidelines even though these reports are not required according to streamline refinance program guidelines.  In this example, the lender overlays result in additional closing costs -- appraisal report and credit report fees -- and a longer mortgage process for borrowers.  

Why Do Lenders Use Overlays?

You may be asking why lenders use mortgage qualification guidelines that are tougher than generally required by industry standards? Their answer is that it helps them manage risk. Most lender overlaps apply to borrowers with a specific set of circumstances. For example, lenders may require a higher down payment for borrowers with lower credit scores. Lenders may also apply a lower debt-to-income ratio for borrowers with lower credit scores. Mortgage lenders overlays may help reduce the risk of default or foreclosure and better protect themselves in the event the borrower cannot repay the mortgage.  If lenders sell a bad mortgage to Fannie Mae, Freddie Mac or another party, they may be required to buy back the loan, which they do not want to do.  Plus it could expose the lender to significant legal and financial risk.  Applying lender overlays helps minimize the risk that lenders will be required to buy back a mortgage after they sell it.

How Do Lender Overlays Impact Borrowers?

Because lender overlays are designed to manage risk, they affect higher-risk borrowers more than lower-risk borrowers. For example, borrowers with lower credit scores or who make smaller down payments are likely to be impacted more by lender overlays than borrowers with higher credit scores who make down payments of at least 10%. So while lender overlays must be applied equally to all applicants according to government regulations, they affect certain higher-risk applicants more than others.

What Borrowers Should Know About Lender Overlays

From an applicant’s standpoint it important to understand the lender’s qualification requirements before you apply for your mortgage, even if you have a deep understanding of the mortgage program. For example you may know the qualification guidelines for the FHA mortgage program or Fannie Mae 97% loan-to-value (LTV) ratio / 3% down payment program but lender overlays may make it harder to qualify. Borrowers should thoroughly understand the lender’s qualification requirements upfront to avoid negative surprises when you apply for your mortgage.

It is also important to highlight that lender overlays and underwriting in general vary by lender. One lender may apply one set of overlays while another lender may apply a different set of overlays or use no overlays at all. One lender may reject your application while another lender with different underwriting policies approves your application.  This is another reason why it is important for borrowers to shop several lenders for a mortgage.

We recommend that you contact multiple lenders in the table below and request mortgage proposals. Comparing lenders and loan terms enables you to find the mortgage that best meets your needs.

Current Mortgage Rates in Ashburn, Virginia as of May 25, 2024
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Rate data provided by RateUpdate.com. Displayed by ICB, a division of Mortgage Research Center, NMLS #1907, Equal Housing Opportunity. Payments do not include taxes, insurance premiums or private mortgage insurance if applicable. Actual payments will be greater with taxes and insurance included. Read through our lender table disclaimer for more information on rates and product details.

Related FREEandCLEAR Resources


Huang, Li-Ning.  "Survey Shows Lenders' Limited Credit Overlay Practices."  Perspectives.  Fannie Mae, July 28 2015.  Web.

About the author
Michael Jensen, Mortgage and Finance Guru

Michael is the co-founder of FREEandCLEAR. Michael possesses extensive knowledge about mortgages and finance and has been writing about mortgages for nearly a decade. His work has been featured in leading national and industry publications. More about Michael

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