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What is a Mortgage Lender Overlay?

What is a Mortgage Lender Overlay?

    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.

  • Rate Details*
    Loan Program:  
    Monthly Payment:  
    APR:  
    Rate:  
    Points  More Info:
    Points: Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
     
    Total Lender Fees:  
    Loan type:  
    Property Value:  
    Loan to Value:  
    Credit Rating:  
    Date Submitted:  
    Monthly Housing Payments
    P & I More Info
    Principal & Interest: A periodic payment, usually paid monthly, that includes the interest charges for the period plus an amount applied to the reduction of the principal balance.
    Mortgage Insurance More Info
    Mortgage Insurance: The monthly cost for a policy that protects the lender in case you’re unable to repay the full amount of the loan. It is typically required for loans that have a loan-to-value ratio between 80% to 100%.
    (Estimated)
    Property Tax More Info
    Property Tax: (Also called "Real Estate Tax.") Property taxes are government assessments on real estate property. With mortgage financing, the local, county or state tax assessment on real estate property is considered part of the monthly housing obligation and typically collected and set aside by the lender ...
    (Estimated)
    Homeowner Insurance More Info
    Homeowner Insurance: or also commonly called hazard insurance, is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one’s home, its contents, loss of its use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.lender ...
    (Estimated)
    Homeowner Association Fee More Info
    Homeowner Association fee: (HOA) fees are funds that are collected from homeowners in a condominium complex to obtain the income needed to pay (typically) for master insurance, exterior and interior (as appropriate) maintenance, landscaping, water, sewer, and garbage costs.
    (If Any)
    Total Monthly Housing Payments
    Lender Fees
    Points More Info
    Points Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
    Origination Fee More Info
    Origination Charge: A loan origination charge is a fee charged by the lender for evaluating, processing, and closing the loan.
    Credit Report Fee More Info
    Credit Report Fee: Fee charged to obtain an applicant’s credit history prepared by one or all of the three major credit bureaus. Used by lender to determine the borrower’s creditworthiness.
    Tax Service Fee More Info
    Tax Service Fee: A fee charged by the lender to cover the cost of retaining a tax service agency. These agencies monitor the property tax payments on the property and report the results to the lender.
    Processing Fee More Info
    Processing Fee: A processing fee is a charge by the lender for clerical items associated with the loan. Examples of processing include loan set up, organization of loan conditions for underwriting, and preparing required disclosures for the borrower.
    Underwriting Fee More Info
    Underwriting Fee: A fee charged by the lender to verify information on the loan application, authenticate the property’s value, and perform a risk analysis on the overall loan package.
    Wire Transfer Fee More Info
    Wire Transfer Fee: In most cases lenders wire funds to escrow companies to fund a loan. Commercial banks that perform this function will charge the lender so the fee is generally passed on to the borrower.
    (If Any)
    FHA Upfront Premium More Info
    FHA Upfront Premium: A fee paid in cash at the close of escrow or more commonly it is financed into the loan. These premiums are pooled together by the FHA and are used to insure the risk of borrower default on FHA loans. FHA upfront premiums are prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of the loan, they are entitled to a partial refund of the FHA upfront premium paid at loan inception.
    (If any)
    VA funding Fee (If any)
    Flood Fee
    Other Fees More Info

    Other fees could be either additional Administrative Fees that a lender charges or it could be a Flat Fee to cover all lender charges such as: (Origination Fees, Points, Underwriting and Processing Fees, Credit Reports and Tax Service Fees)

    The flat fee does not include prepaid items and third party costs such as appraisal fees, recording fees, prepaid interest, property & transfer taxes, homeowners insurance, borrower’s attorney’s fees, private mortgage insurance premiums (if applicable), survey costs, title insurance and related services.

    Total Lender Fees
    *Actual rates and other information may vary. Sponsored results shown only include participating lenders. The information you enter on this page will only be shared with lenders you choose to contact, either by calling the phone number or requesting a quote.
    Current Mortgage Rates as of December 11, 2018
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
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  • Sources

    Lender Overlays: http://www.fanniemae.com/portal/research-insights/perspectives/072815-huang.html

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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