The First Lady Of Finance®

From my February 28th, 2010 column in the Sacramento Bee…

The loan process has many layers and is often overwhelming to borrowers especially with everything changing so often. In making mortgage loans, lenders use guidelines regarding the borrowers and the property. During the early 2000’s, guidelines were relaxed quite a bit causing many loans to be made that later resulted in foreclosures. Investors took huge losses as well and many lenders went out of business.

Generally speaking, underwriting guidelines for most loans are set by Fannie Mae, Freddie Mac, FHA (Federal Housing Administration) or VA (Department of Veteran Affairs). These guidelines are set so lenders know what each of these agencies will accept and underwriters know how to underwrite the loan accordingly.

Some guidelines cannot be changed or the loan will not be saleable. For instance, FHA (Federal Housing Administration) is changing the upfront premium on their loans after April 5^th 2010.   An upfront premium is mortgage insurance that is added upfront to the loan to reduce the monthly premium which makes it easier for borrowers to qualify. Mortgage insurance protects the lender when there is less than 20 percent down. FHA loans only require 3.5 percent down but loans with so little down are considered very high risk loans which is why they have the mortgage insurance. The new upfront premium will be 2.25 percent, up from the current 1.75 percent.

Beyond these guidelines however is where some of the confusion comes in. Lenders need to get the money from Investors who will buy the loans. Investors can have some addition guidelines—these are called Overlays.

Overlays are put in place to further protect the Investor from more loan defaults. One example of an Overlay in place by many Investors is regarding credit scores. While FHA, VA or FannieMae may have a limit that they won’t go below, a certain Investor may have an even higher credit score requirement and the lender must follow that guideline in order to be able to sell the loan to the Investor.

Low credit scores are one of the greatest risk factors in making a loan. Lenders are seeking to lessen the risk as much as possible and having higher credit scores required is one of the easiest ways to lessen that risk. Lenders then are requiring this because it is an Investor Overlay.

Another Overlay can have to do with the loan amount. The Lender may require an add-on (extra cost) for a loan amount that is too low or may have a minimum loan amount that they will do. They may also require an add-on for a high loan to value (LTV).

Still another Overlay may have to do with appraisals. The Investor may require more than one appraisal on a property if the loan is over a certain amount, it is a non-owner property or for some other reason that concerns that particular Investor.

Investors look at where the greatest number of defaults were with loans and that is where they are more prone to add Overlays. Cash-out loans for instance are yet another area where Overlays may occur.

Overlays mean that Lenders not only have to follow the underwriting guidelines of whatever program a borrower is using like FHA but then they have to check out any Overlays a given Investor may be requiring.

Sometimes real estate agents or borrowers themselves hear about some new change in say FHA loans—something that seems to have eased up on some guideline. The problem is that lenders may not be able to put that change into affect for a while because they need to find out what the Investors are going to do about that regulation. This time delay can be very frustrating to all involved, including loan consultants who want to make the loans.

It may seem that Overlays have made getting loans even more difficult but in an era where taxpayers have had to bailout large banks and many homeowners have lost their homes, using more caution in making loans may ultimately serve borrowers more.

Now is such a wonderful time to buy if you really are qualified to buy—low sales prices, low interest rates—but the right time isn’t the same for all buyers.

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