The return of overlays

[Judah Hoover]

The return of OVERLAYS

Not Layovers, those are delays that happen at crowed airports. We aren’t likely to see them anytime soon… sadly.

I am talking about lending overlays. All banks assess risk differently and are permitted to set more restrictive guidelines than a lending program calls for. So if because of the times we live in a local lender decides to require a 640 credit score for an FHA loan when 620 would have cut it a few months ago that is an example of a lender tightening an overlay. In fact… FHA has a 580 minimum FICO score… any requirement higher is technically an overlay.

A more applicable example to those of us that invest in real estate is seasoning requirements. Some lenders will require 6 months, some 12… and some none at all as long as you can document the repairs and justify the increase in value.

This is important today and in the market times coming because whereas for the past decade lending standards have been converging and loosening, they are about to diverge and tighten, and how they tighten will not be uniform. As we recovered from “the great recession” lending programs looked more and more alike from bank to bank and it got to the point that there was very little difference. It also got pretty easy to get loans done.

Do not expect that to continue. Banks will always be lending to qualified applicants but how much they lend and how they will lend will differ. At bank A you may be able to get 80% LTV loans done as an investor, but at bank B they may only go up to 75%. To mitigate the increased risk bank A will require a higher credit score or look closer at the Debt Service Coverage Ratio (DSCR) of the loan.

Establishing relationships with local bankers is always important, now more so than ever. It is also a good time to talk to mortgage brokers, because they can do much of the shopping for you and have wholesale relationships on the back side. Many mortgage brokers are “brokers” in name only. They are actually lenders that then sell the loan on the secondary market. I spent 10 years as a direct mortgage lender. I called myself a mortgage broker because it’s a term people understood, and I had great relationships with my wholesale channels. For example, I could get you a Wells Fargo loan at a better rate with less overlays than you could get if your mother worked there.

The times ahead are going to be interesting, but I have seen corrections before. I am excited for what we are going to see. The market ahead is going to be very different, but there is always opportunities.