Everyone knows that shopping around for a mortgage can help you get the best interest rate. But it can also help you qualify for a mortgage as well.
Each lender has its own mortgage approval standards, in terms of credit scores, income requirements, debt levels and more. In addition, those requirements can vary depending on where the property is located and can even change from week-to-week, or day-to-day. So just because one lender rejects your application, it doesn't mean another won't accept it.
Some lenders more stringent than others
Lenders have these requirements even though the agency guaranteeing the mortgage - Fannie Mae, Freddie Mac, FHA, VA - have already established standards for the loans they'll accept. However, those guarantees don't ease all a lender's concerns about a home loan defaulting, so they impose their own, more stringent requirements.
These are overlaid over the requirements of the FHA, VA, etc., so they're known as overlays. To be specific, they're requirements set forth by the investors that lenders want to sell the mortgages to, so their full name is investor overlays. Different lenders sell their loans to different investors, so the rules vary from lender to lender.
Common mortgage overlays
One of the most common overlays is on credit scores. For example, the FHA will guarantee mortgages to borrowers with credit scores as low as 500, but in reality, few lenders will go below 620-640. That's an overlay. In addition, they may impose other requirements to approve credit scores below 680 or so, such as additional income documentation.
Another example is with the FHA Streamline Refinance. By the FHA' rules, pretty much all you have to do to qualify is be current on the last 12 payments on your FHA mortgage. But the lenders who actually refinance the loan will likely want to check your credit score and verify employment, at the very least.
Other common overlays have to do with debt-to-income limits, employment history, loan amount, down payments or equity, neighborhood where the property is located, bankruptcy or foreclosure history, and appraisals. Some lenders may require repeated appraisals if they have reservations about the first one, for example.
Same loan programs, different guidelines
This creates a lot of confusion, not only for borrowers, but for loan officers as well, since they have to keep track of and apply all the various requirements of different investors who may purchase the mortgages they originate.
On positive note, what this means for you as a borrower is that just because one lender rejects you for a mortgage, it doesn't mean another won't approve you, even if it it's a loan from the same program (FHA, VA, USDA, Fannie Mae, Freddie Mac). Or you may get approved, but another lender may have more generous terms because its overlays are not as strict, as least as far as they apply in your case. That's why it pays to shop around.
Smaller lenders may be more flexible
You also may find that some lenders are more flexible than others. Big banks tend to be fairly rigid - they set their loan requirements and overlays as matters of corporate policy, and loan officers have little room to vary from them. Smaller banks and credit unions, however, often have less restrictive guidelines and may loosen certain requirements if they see other aspects that give them confidence the loan will be sound.
If you're having trouble finding a lender who'll approve you for a mortgage, you might consider seeking the services of a mortgage broker. Brokers work with numerous lenders and specialize in matching a borrower's needs to the right lender. You do pay a higher premium for their services than you would if you arranged for the same loan yourself, but for borrowers with special needs, it can be well worth it.