Loan denials are not uncommon. Even those who meet the requirements for an FHA, conventional or VA loan find themselves declined. What gives? You know you meet the credit score and debt ratio requirements. Why did the lender turn you down?
It happens because of lender overlays. These are extra requirements a lender adds to a loan program. Think of it like a hovering parent. They want to make sure you aren’t going to default on your loan. The requirements the loan programs set are the bare minimum requirements. Many lenders go above and beyond these requirements. They want to ensure you are a good risk. After all, it is the lender funding the loan.
The Most Common Lender Overlays
Before you start looking for a lender with no overlays, learn the most common requirements lenders add.
- Credit scores – Credit scores are often the largest problem. For example, the FHA allows scores as low as 580 with a 3.5% down payment. They even allow credit scores as low as 500 with a 10% down payment! Most lenders won’t go below 620 and that is being a bit forgiving. They want a ‘good’ credit score despite what the program requires. These guidelines may allow more borrowers to buy a home. But, this puts the lender at great risk for default. It is not uncommon to find lenders with credit score overlays.
- DTI ratios – Debt-to-income ratios determine how well you can afford the loan. It’s no wonder that lenders want to tighten the reins on this one. We will use FHA loans as an example again. Right now, they allow ratios of 31/43 for loan approval. That means 31% of your gross monthly income can cover your mortgage payment. It also means 43% of your gross monthly income can cover your total monthly expenses. This is too liberal for some lenders. Considering conventional ratios are 28/36, it makes sense to have tighter requirements.
- Down payments – An overlay on down payments is not as common as the previous two requirements. It does happen, though. If a lender feels you are a higher risk, they may require a higher down payment. This means more than 3.5% down on an FHA loan or 5% down on a conventional loan.
Streamline Loans Often Have Overlays
Streamline loans are perhaps the most common loans with overlays. It makes sense, though. What lender wants to give a loan based on payment history and occupancy of the property? A little reassurance that you can afford the loan helps. A higher credit score, lower debt ratio, or a large amount of equity often helps.
This is not to say that lenders won’t just abide by the streamline rules. It does mean it may be harder to find a lender willing to do so, though. Streamline loans are meant to be more affordable than the original loan, but if it’s a new lender, it’s new money. In the eyes of the lender, it’s a new risk for default.
Finding a Lender With no Overlays
Now your goal is to find a lender without overlays. This is not an easy task. If you meet some of the requirements, you may not care. But, if you have unique circumstances, it may matter.
The easiest way to find the right lender is to shop around. Don’t stick with just one lender. Apply with at least 3 lenders within a short period. Your credit score will not be affected by the multiple inquiries. Just make sure you do it within a small window.
Before you apply with any lender, though, ask questions. Be honest about your situation. Let the loan officer tell you what he thinks. He knows the loan programs available and what the bank requires. He should be able to tell you straight up if you have a good chance of approval. This can limit the needless inquiries on your credit report.
If you shop around and still keep running into overlays, you have another option. You can use a mortgage broker. These are third parties that work with many lenders. A good broker will know the requirements of each lender. They will know where the best place is to send your application. This takes the work off your shoulders and gives you a bit more expertise.
Interest Rate may Vary
Keep in mind, interest rates are based on many things, including risk. If you do find a lender without additional restrictions, you may pay a higher interest rate. The lender has to make up for the higher risk somehow. By removing the overlays, they put themselves at risk for default. They can counteract it with a higher interest rate. They may also have higher fees. Origination fees or points are often charged on higher risk loans. It’s like a little give and take the lender does with you.
Know Your Situation
The best thing you can do is know your situation. Understand your credit score and credit history. Calculate your debt ratio and your LTV. This way you know what to tell lenders. You also know what you need to shop for. Look at the standard requirements for FHA, VA, and conventional loan programs. Then compare your situation to these programs to see where you fit in. Then you can shop for the right lenders based on your situation.
Overlays are meant to protect lenders and even borrowers. They are not a way for banks to restrict lending. They just prevent borrowers from taking on loans they could not afford. It might look good on paper, but when the bills start coming, it may get difficult. Trust in the process and find the loan that is right for you.
If you can’t find a lender without overlays, figure out how to improve your situation. Increase your credit score, lower your debts, or save for a higher down payment. Then you can apply again. Until then, though, keep shopping. Chances are there is a lender out there for you.