You work hard to settle your financial debts, improve your credit score, and save a substantial down payment for your new home. Consequently, you applied for a mortgage and thought it would be approved, but you were denied. Despite meeting the general financing guidelines, specific lender requirements called mortgage overlays might have invalidated you from getting the home loan you want.
For the lenders to review your application and possibly approve the loan, you need to overcome several hurdles. Read on to learn more about mortgage loan overlays and how to take care of them when purchasing a home.
What is a Mortgage Overlay?
Federal regulations specify the criteria that borrowers must meet to qualify for a home loan. However, lenders can further reduce the possibility of a borrower defaulting on a home loan by introducing stringent rules known as mortgage overlays.
These additional regulations can be applied to Freddie Mac and Fannie Mae loans and government-backed housing loans, including FHA, USDA, and VA loans.
Mortgage overlays are often caused by unstable market conditions, which increases the risk for lenders. It may also result from red flags in your financial status, the loan types, or the property type you are considering.
Factors affecting mortgage overlays
Typically, you will know if you are subject to mortgage overlays when acquiring a home mortgage. The following are examples of mortgage overlays that might affect you:
i) Debt-to-income ratio (DTI)
Traditional loans generally have a maximum DTI of 43% (the sum of all your monthly debt payments divided by your total monthly income). However, some creditors require a lower debt to income ratio than the 43% rate.
ii) Credit history
The lender needs to ensure that you can manage your debt responsibly. Therefore, they require a minimum number of credit reports and years of experience to qualify for a home mortgage.
iii) Employment records
Applicants with insignificant or shaky work histories might not acquire a mortgage even if they meet other requirements.
iv) Credit rating
Federal law enables you to qualify for an FHA loan with a credit rating of 580 and a 3.5% down payment (if the rating is as low as 500 with a deposit of 10%). However, many lenders offering FHA loans consider candidates with a credit score of 620 or higher. Traditional loans are readily available to borrowers with a credit report of 620. But some lenders established a minimum rating at 640 or greater. USDA financings do not have federally required minimum credit records, but many lending institutions require at least 640 credit scores.
v) Type of property
Some lenders restrict the types of properties that would qualify for a mortgage. Therefore, be careful while selecting your real estate as it won’t hurt your =expectations.
According to federal guidelines, consumers in bankruptcy liquidation are eligible for housing loans. Still, most lenders have overlays and require a waiting period of one or two years.
vii) Down payments
Some traditional mortgages require a 3% down payment, but the lender does not always follow this suit. Some creditors will not approve loans unless you contribute 10% or even 5% to the table. Also, some lenders restrict or forbid the use of gift credit, i.e., the money you deposited as a down payment and given to you as a gift.
viii) Cash reserves
Federal mortgage regulations generally require several months of resources to qualify for a mortgage, but some lenders discourage borrowers who hide their mortgage payments for less than six months.
ix) Collections and charge-offs
The FHA guidelines don’t demand full payment and charge-offs to qualify for a home loan, but some lenders have overlays that prevent applicants with overdue bills from qualifying loans.
Can mortgage overlays be avoided?
You can avoid mortgage overlays by comparing quotes from different lenders. Some lending companies don’t have overlays that restrict you from borrowing, or your financial status may be strong enough to avoid working with other lenders.
When you find a lender in line with your requirements, they may be willing to eliminate some overlays in exchange for higher mortgage rates or a higher down payment.
Still no luck? Consider turning to the drawing board to improve your reputation and overall financial situation before trying again later.
How to prepare your credit for a home mortgage
The first step in preparing a mortgage is to check your creditworthiness to understand your situation. You can get a free print of your bank records from three institutions: TransUnion, Experian, and Equifax at annual credit report.com.
Review your credit scores reports and note sections that need improvement. If you find any information that seems inaccurate or out-of-date, contact the appropriate lender immediately or file a dispute with a credit bureau.
i) Pay all your bills and debts on time
Payment history accounts for 35% of your FICO score, so late payment will negatively impact your reputation. The creditor might consider you as a riskier borrower and charge you a higher interest rate.
ii) Get current on overdue debts
If you do not update the expired accounts, then your reputation will be affected every month. If possible, cancel foreclosure and depreciation bills to apply for a mortgage when you have unpaid bills.
iii) Reduce credit card balance to lower your credit utilization ratio
Approximately 30% of your FICO rating depends on the amount owed in your account. Also, the comparison between your revolving balance and your credit limit (credit utilization) is the main criterion. The lower credit usage rate is better, so maintain your credit utilization rate at least below 30%, as this will significantly impact your credit.
v) Don’t apply for a new loan
Each new application creates a complex query that can temporarily reduce your grades by a few points. It is clear that one or two credit inquiries are not enough to change your credit profile. But if your score is at the edge of the scoring range, they will make a difference.
If the lending institutions refused your current mortgage, reach out to the creditor to learn why your application was not approved. The mortgage loan officer may give insights to assist you in solving problems— causing overlays to be applied on your documents.