My Lender Just Imposed a Mortgage Overlay: What’s That Mean for Me?

The process of preparing to buy a home may be daunting enough under normal circumstances, especially for first-time homebuyers: You’ll typically need to save for a down payment, ensure your credit-worthiness, and secure a loan — and that’s to say nothing of the home search, escrow, and closing processes.

And as the pandemic crisis washes over the housing market (not to mention the world economy), you may find the process now involves some daunting new steps.

One might come in the form of a mortgage overlay — a concept that always existed, but you might not have heard of it until now. In short, a mortgage overlay is an additional standard that a lender imposes above and beyond the basic requirements of a government-backed or conventional loan. And it can pose new challenges for would-be borrowers.

You’re likelier now to hear that your lender is about to impose a mortgage overlay in these unusual and uncertain times. And as unsettling as it might be, it helps to be prepared and to know your options. So if you learn a mortgage overlay is affecting you, brush up on what you need to know using our expert-back primer for how to understand and navigate the territory as painlessly as possible.

What is a mortgage overlay?

First, let’s define mortgage overlay simply: A mortgage overlay is a set of rules that a lender imposes on top of the published guidelines.

These can apply to mortgage loan programs that are backed by the government — for instance, FHA, VA, and USDA loans. These loans are popular because entry-level buyers can get one fairly easily, namely due to low qualifying credit scores and low down-payment requirements.

For example, the FHA requires buyers to put down 3.5% and to have a minimum 580 credit score — so that’s a pretty reasonable starting point.

But with mortgage overlays, lenders may draw up their own set of internal rules for approving buyers for loans. For example, a lender might impose an overlay that requires an FHA loan buyer to put down 10% and have a minimum 660 credit score — a much higher barrier to entry.

Not just for government-backed mortgages, overlays can also apply to conventional mortgages above and beyond the standards outlined by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. A conventional loan typically requires a minimum credit score of 620 and a minimum down payment of 3%. But with a mortgage overlay, a lender might ask a conventional loan buyer to put down 20% and have a minimum 700 credit score — and that’s a much taller order.

Overlays have always existed. But “right now, during the COVID pandemic, there have definitely been additional overlays placed,” says Jessica Sanchez, Director of Underwriting & Loan Management at HomeLight Home Loans.

She adds, “It hasn’t affected the conforming loan space too much — those run-of-the-mill standard mortgage loans. But it has affected the government lending side of the world: FHA, VA, USDA.” (The better news, Sanchez notes, is that the extent of the current overlays is probably temporary.)

To sum up, lenders can impose overlays essentially at any time. And it could put your ability to get a loan in jeopardy.

Why would a lender impose an overlay?

In short, lenders usually impose mortgage overlays because of risk.

When the economy is suffering, lenders could impose overlays to protect their own bottom lines and stop giving out riskier loans. So they start looking more carefully at risks specific to the buyer, and to the risks associated with the larger economic climate.

For example, perhaps you might simply be considered a higher-risk buyer as an individual. Lenders might discover this during underwriting, when they realize that your debt-to-income ratio is higher than they originally thought, or they discover another factor influencing your creditworthiness.

Sanchez notes that lenders look at past credit and past financial behavior to assess the likelihood of repayment and the riskiness of the loan. When buyers have poor credit or high debt-to-income ratios, lenders will impose additional fees or charge more in loan interest to offset the risk of the loan.

Mortgage overlays also show up when it’s a riskier time to buy — and given the pandemic crisis, that’s coming into play now, too.

There’s another reason, unrelated to risk, why you might see an overlay, too, Sanchez says: “Operational bandwidth.” In other words, the lender might impose a mortgage overlay if the loan is just really difficult to implement. Certain loan types are harder for lenders; They take more time and more money, more people to review, and so forth — so the lender might impose an overlay as a counterweight on these loans.

How can I avoid overlay problems?

There’s not much you can do to prevent an overlay because it’s a riskier time to buy, but you can and should be as honest about your financial situation as you possibly can when you apply for a loan.

You should also be cognizant of the comfortable top of your price range, and try to shop as far below it as your lifestyle can manage; If an overlay is imposed before closing but you aren’t trying to buy a house at the very top of your approval level, your loan will have a better chance of surviving the overlay untouched.

There’s an overlay, and now I have a problem. Can I fix it?

If you’re facing a mortgage overlay, talk to your real estate agent about your options. “Shop around, do your research, get informed,” Sanchez says.

Perhaps you might talk to another lender and start the loan process over again. “It’s always very good for a buyer to do their research, so definitely shop around to three different mortgage lenders: One lender is telling you they have an overlay, and maybe the other lender doesn’t have that same overlay.” (Note that lenders often share similar overlay terms, and are even more likely to do so in situations like a global pandemic.)

Or perhaps you might work with your loan officer to investigate a different type of loan program that might have a higher interest rate and then hope to refinance out of it later. Perhaps you can also put more money down to make the loan more attractive and less risky to your lender.

In short, Sanchez says, “The best advice I can give: Work with your loan officer. And do your research.”

And when you’re getting a loan to buy a home — global pandemic or not — that’s always good advice.

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