Lender Overlays and Why Your Credit Score Matters for Mortgage Applications

By Michael Zuren, PhD Updated on 7/20/2017

credit scores and mortgage approval The interest rates that mortgage lenders usually offer are based on a consumer's credit scores (risk-based pricing). Credit scores are the lender's indicator of risk of borrower default.

A credit score is a calculation which measures the probability a consumer will allow debt to become 90 days late or more, or default on debt repayment.

The risk is evaluated individually by various lenders. This is where the “lender overlay” may come in. These overlays are expanded guidelines for credit minimums above of what Freddie Mac, Fannie Mae, the VA or FHA would approve.

These overlay adjustments are frequently added to mortgage loans with consumer credit scores of 680 or less. Below are some pricing adjustment examples from the Fannie Mae selling guide from January 8, 2014. All the examples are taken from fixed-rate mortgages. Notice that the minimum credit score for Fannie-backed mortgages was 620 (exceptions to which are limited):

All Eligible Mortgages (Excluding MCM): LLPA by Credit Score/LTV

	< 60.00% LTV	60.01 to 70% LTV	70.01 to 75% LTV	75.01 to 80% LTV	80.01 to 85% LTV	85.01 to 90% LTV	90.01 to 95% LTV
Credit Score	_	_	_	_	_	_	_
>740	-.25%	0	0%	.25%	.25%	.25%	.25%
720 to 739	-.25%	0%	.25%	.50%	.50%	.50%	.50%
700 to 719	-.25%	.50%	.75%	1.00%	1.00%	1.00%	1.00%
680 to 699	0	.50%	1.25%	1.75%	1.50%	1.25%	1.25%
660 to 679	0	1.00%	2.00%	2.50%	2.75%	2.25%	2.25%
640 to 659	.50%	1.25%	2.50%	3.00%	3.25%	2.75%	2.75%
620 to 639	.50%	1.50%	3.00%	3.00%	3.25%	3.25%	3.25%

Mortgage companies and lenders can impose additional overlays. State first time home buyer programs will sometimes have individual credit requirements. For instance, the State of Ohio first time home buyer program requires a minimum middle credit score of 640.

How Credit Score is Calculated

FICO scores are credit scores calculated by applying algorithms developed by the Fair Isaac Corporation. They are a measurement of risk based on past credit history and use of current credit. The TransUnion (one of the major credit bureaus) FICO score, for example, ranges between 300 and 850. Credit scores are updated every 30 days, to consider your current credit balances, payment history, and account status.

The TransUnion FICO score calculation is composed of the following factors:

35% payment history
30% Percentage of debt used on revolving debt
15% length of credit history
10% type of credit used
10% credit inquiries

Past credit information is reported on your credit report. Credit inquiries remain on a credit report for two years. Bankruptcies are reported for ten years, whereas revolving accounts and installment loans are reported for seven years.

Recent credit activity has a greater impact on credit scores than older, inactive accounts. One caveat to this rule would be paying older collections. If a collection account has not been updated in the past two years but is paid, it will likely have an adverse impact on the credit scores. The credit scores will likely decrease because, when the collection account is updated it will be reported as recent activity.

Correcting Credit Report Inaccuracies

Disputed accounts are not considered into credit score calculation. Most lenders require disputed accounts to be settled, or the dispute verbiage be removed thereby reflecting a more accurate depiction of an individual’s credit score.

Before applying for a mortgage, check your credit report for disputes. You may have inaccurate credit scores, which may be lower once the dispute verbiage is removed.

What else can you do to improve your credit scores?

Keep your revolving credit balances below 35% of their available limits.
Increase your credit limits.
Restrict the inquiries on your credit report.
If a trade line (reported account) is inaccurate, ask that the account be removed. Disputing only masks the derogatory credit from being calculated in your credit score.
Remember joint accounts or co-signed accounts will be reported on both parties’ credit reports. If either party is late or goes into default both credit histories will be tarnished.
Be proactive and review your credit report at least twice per year.

For additional information, we have another guide for quickly boosting your score here: Fast Ways to Improve Credit Score.