Lender Overlays Negate FHA Guidelines

When it comes to government regulations and banks, “You can” doesn’t translate into “You will.” This was the case with loan modifications and “underwater” refinances, and now is the case with the new FHA guidelines.

The new FHA guidelines allow a minimum credit score of 500 when the borrower makes a 10% down payment. Borrowers with only a 3.5% down payment are eligible with a score of 580. Gift funds are allowed, as are seller contributions.

That sounds good, but in reality, only 5-10% of all banks will approve such loans – and then only if all the other requirements are met and borrowers are willing to pay higher interest rates.

Most lenders impose their own requirements, known as “overlays.”

Many banks adhere to an in-house credit score overlay, regardless of what FHA says they “can” do. But there are other overlays as well.

Some lenders will go along with the low score/ low down payment requirement, but will prohibit the use of gift funds. Others impose stricter debt-to-income ratios. Others impose overlays related to job security and primary residence.

Some banks even impose different requirements for borrowers who apply through their own retail branches as opposed to those who apply through a mortgage broker.

As it turns out, the bottom line is that you still need a credit score of 640 or higher if you want to be assured of getting a mortgage loan. You also need a reasonable debt to income ratio and a reasonably secure source of income – just as everyone did before the whole mortgage crisis began.

Some are up in arms…

The National Community Reinvestment Coalition has filed a complaint with HUD, charging 22 lenders with violating several laws, such as the Federal Fair Housing Act, by imposing these overlays.

They allege that these banks are discriminating and illegally denying qualified African-American and Latino borrowers access to FHA insured loans.


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