What Are Lender Overlays, and How Do They Impact VA Loans?

Everything You Need to Know before Choosing Your VA Lender

Robin Kocherhans Robin Kocherhans / Published Dec 31, 2021, 12:35 PM / Modified Mar 22, 2022, 10:04 AM

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Looking for a VA loan? Not all VA lenders have the same qualification requirements.

That's why understanding VA lender overlays when applying for a mortgage loan can save you time. It can also help you determine the right lender for your situation.

So let's dive on in! To make sure you really understand overlays and how they can impact you, we'll look at:

  • What lender overlays are
  • The VA's lending requirements
  • The most common overlays
  • Why lenders add overlays, and
  • How to deal with lender overlays

What is a lender overlay?

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Ready to start searching for a home? Here's what you need to know first!

Lenders overlays are additional requirements lenders put onto the loan that exceeds the standard qualification guidelines for a loan program.

VA loans are offered through a U.S. Department of Veterans Affairs program for active service members, veterans, and spouses to access mortgages.

Also, it has flexible requirements and a host of benefits, such as:

  • Competitive interest rates
  • No down payment
  • Relaxed credit score thresholds
  • No mortgage insurance

But it's issued by private lenders who're backed by the federal government.

Despite this backing, lenders can lose large amounts in defaults. So when a VA loan has high-risk potential, private lenders often choose to set additional requirements to control that risk.

These additional requirements are known as VA lender overlays, and they can vary widely from lender to lender.

But, while the addition of VA lender overlays means safer business, it can make it trickier for higher-risk borrowers to qualify for VA loans.

What are the VA's requirements?

In addition to the VA's service eligibility requirements, their guidelines for lenders include:

1. Credit score

A credit score helps lenders decide how likely you are to repay your debts. They range from 300–850 and are based on your debt history and ability to repay on time.

The VA doesn't require a minimum credit score. However, lenders can apply their thresholds to help reduce risk and keep their default rates low.

2. Debt-to-Income Ratio (DTI)

The debt-to-income ratio is used to determine a borrower's repayment capacity and financial health.

It's calculated by dividing your monthly debts by your gross monthly income. These debts include such things as:

  • Monthly rent and house payment
  • Monthly alimony and child support payments
  • Student, auto, and other monthly loan payments
  • Credit card monthly payments
  • And any other recurring debts

However, it's important to know that the VA doesn't set a maximum DTI. However, they do say that if it is above 41% , your lender may be required to look at compensating factors before approving it.

3. Seasoning after bankruptcy or foreclosure

A seasoning period is a set amount of time you have to wait following your bankruptcy or foreclosure before you can qualify for another loan.

For bankruptcy, the VA guidelines suggest 12 months from your Chapter 13 filing date. For foreclosure or Chapter 7 bankruptcy, the period is typically two years.

These standard waiting periods for VA loans are shorter than the waiting periods required for a conventional loan after foreclosure or bankruptcy. However, individual lenders may choose to set their own longer seasoning periods for these issues.

4. Cash reserves

While the VA doesn't typically require cash reserves for most VA loans, there are some special situations where they may be required.

These situations can include:

  • Being within 12 months of your separation date
  • Purchase of an allowed multi-unit property

In addition, most lenders will want to see that you have enough money available to cover the closing costs of the VA purchase loan.

5. Collections and charge-offs

Collections and charge-offs are when lenders write off your debt account as a loss and close it to future charges.

VA guidelines allow for loan eligibility with outstanding collections and charge-offs. However, outstanding debts affect your credit score, and lenders can choose to set their own credit thresholds.

Also, repayment amounts for collection debts will increase your DTI.

6. Property eligibility

The property you purchase with a VA loan must be for primary personal occupancy. The VA stipulates you must intend to occupy the home within 60 days of closing (some exemptions for this timeframe exist).

7. Allowed co-borrowers

A co-borrower is any additional borrower listed on the mortgage whose income, assets, and credit history are used to qualify for the loan.

he VA doesn't require any down payment if your spouse is your co-borrower.

While you can have co-borrowers with non-spousal relationships, the VA won't guarantee a non-military borrower. In this case, the other party may need to make a down payment for their portion of the loan.

What are the most common overlays?

The most common VA loan overlays you will encounter are:

  • Minimum credit score
  • Maximum DTI ratio
  • Additional seasoning time for foreclosure or bankruptcy

1. Minimum credit score overlays

Though the VA doesn't set a guideline for a minimum credit score, many private lenders choose to set their own minimum score overlay.

For a lot of these lenders, their overlay tends to require that borrowers have a credit score above 620 to 640 to qualify.

If your credit score is below 620, you can search for lenders who don't have this overlay, or whose overlay is below what your score is.

2. Maximum DTI ratio

The VA has a flexible DTI requirement, which means there's no defined cutoff percentage. However, the VA does require lenders to provide additional scrutiny for borrowers with a DTI above 41%.

To make things easier, many lenders choose to set their own maximum DTI ratio. The most common DTI overlay is usually for a maximum of 40–50%.

If you have a higher debt load, but still believe you can afford a home, it is possible to find lenders who are willing to do the extra work in verifying your qualifications and ability to afford the loan.

3. Additional seasoning time for foreclosures or bankruptcies

The VA requires a one year wait from filing chapter 13 bankruptcy and two years for a chapter 7 bankruptcy or foreclosure, which is less than the traditional requirement for conventional loans.

However, if a lender requires more time, it means they have implemented an overlay to control risk.

If you've experienced a foreclosure or bankruptcy but find yourself getting denied for a VA loan even though enough time has passed, we recommend finding a lender who sticks to the VA's guidelines and doesn't impose a seasoning overlay.

Why do lenders add overlays to VA loans?

There are two main reasons why lenders include overlays:

  1. To limit default risk
  2. Ability to sell servicing

1. To limit default risk

The VA acts as a guarantor, allowing lenders to redeem 25% of the loss incurred if a borrower defaults on their loan. This still leaves the lender open to most of the financial burden.

With overlays, lenders can control the potential loss by ensuring loans go to borrowers who are statistically less likely to default.

2. Ability to sell servicing

Many lenders sell on loans in the secondary loan market. Because secondary market investors sometimes look for certain things, their wants can dictate the overlays lenders choose to apply to VA loans.

If a lender is looking to increase loan sales to investors, they may choose to implement overlays that make their loans more attractive via reduced risk.

How to deal with lender overlays

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Having the right conversations can help you avoid or reduce lender overlays

If you're denied a VA loan due to overlays, you have a couple of options:

  1. Improve your situation to meet overlays
  2. Find a lender who doesn't have overlays

While the first option can work, it can be problematic since overlays can vary from lender to lender. So even if you improve your personal qualifications, it might only work for one lender and not be enough to qualify with another.

The second option is usually better. By shopping around for different lenders and finding ones without overlays, you don't have to worry about getting denied for something the VA itself doesn't even require.

If you're looking for somewhere to get started, call our team at Low VA Rates. In addition to having competitive rates, we believe in sticking to the VA's guidelines as closely as possible, so we avoid setting overlays whenever possible.


Now that you understand overlays, you're ready to find the right lender and the right home

Overlays are the thresholds private lenders apply to VA loans, on top of the VA's core loan requirements. They can affect your ability to qualify for a VA loan.

For this reason, and because of the fact that overlays are unique to each lender, comparing lenders and shopping around for your loan is a must. If you're shopping, make sure you ask each lender what overlays they have, if any, so you can make an informed decision.

At Low VA Rates, we're passionate about helping our veterans. We're not afraid of doing a little extra legwork and digging in order to get you approved for a VA loan.

We're a great place to start looking for a VA loan, so you give us a call at (855) 712-5120. Even if we end up not being able to do your loan, we're happy to offer advice and get you pointed in the right direction.