When you’re asked to write a letter of explanation by a mortgage underwriter, look at this as a valuable opportunity to clearly communicate your situation.
Standard mortgage forms often don’t leave space for you to explain any unusual or problematic components of your application. A letter of explanation can allow you to clarify any complications, including glitches in your credit history or employment, to help you qualify for a home loan. And this guide will tell you how to do it.
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What’s a letter of explanation?
A letter of explanation (sometimes called an LOE or LOW) is a document requested by mortgage lenders when they want more details about your financial situation. An underwriter may request a letter of explanation if they run into questions about your finances during the mortgage approval process.
Why do lenders ask for a letter of explanation?
Typically, mortgage lenders will request a letter of explanation when they want to know more about your income, employment or credit. Technically, the lender can ask anything about your financial situation. Anything that strikes the lender as a red flag is fair game for a letter of explanation.
Mortgage lenders express interest in out-of-the-ordinary happenings with your finances because those could prevent you from making future house payments. Check your underwriter’s request to understand what needs explaining.
There are a number of reasons a lender might request a letter of explanation, but here are six of the most common.
Differences in addresses
The Federal Trade Commission (FTC) enforces an address discrepancy rule which puts the burden on mortgage loan originators, brokers, lenders and banks to report your correct address to the various credit agencies. When you apply with an address that differs from the one at the credit bureaus, the lenders view ID theft as a distinct possibility. If you have a valid reason for the inconsistency in addresses, this is your chance to clear up any confusion. For example, perhaps you moved to an apartment while house shopping, weren’t sure how long you’d be renting and applied using your parent’s address.
Interruption in employment
If you’ve experienced a significant gap between jobs and subsequently failed to meet a financial obligation, you can explain the situation and why it won’t happen again.
A letter of explanation can also help if your employment gap was an anomaly. For instance, many workers were laid off during the Covid pandemic but otherwise have an excellent track record of employment. Lenders can be more flexible when they have all the details about your scenario.
Sizeable deposits into one of your accounts
If the underwriter doesn’t recognize the source of a large deposit into your bank account, they’ll ask you to explain why it’s there and where it originated. An example would be that you sold a car to someone and then deposited the check they wrote you.
Late or missing payments
If you’ve made late payments — or missed payments — to creditors then a lender will want to understand why. The cause may be an interruption in employment or a medical issue. If most of your history suggests you pay on time, a letter stating your case should be sufficient to put your lender at ease.
Erratic income
When your income decreases or vanishes, it’s a red flag to the mortgage loan company. Lots of reasons may have caused this decline in income, including having a baby, getting divorced, advancing your education, traveling or starting your own business. In your letter spell out the cause and let the underwriter know that you’ll still be able to make your mortgage payments.
Miscellaneous circumstances
Your credit report may be cause for concern if it shows overdraft fees, considerable cash withdrawals or some other unexplained financial irregularity. If you were a victim of monetary fraud or identity theft, that’s not a deal-breaker, but you will need to include the specifics in your letter.
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How to write a letter of explanation
You don’t need to worry if your lender requests a letter of explanation. These letters are a pretty standard part of mortgage applications.
Here are the important elements that your letter should include:
- Facts. Include all the details with correct dates and dollar amounts.
- Resolution. Explain how and when the situation was resolved.
- Acknowledgment. It’s important that the letter outline why the problem won’t arise again. Recognize if and how you could have avoided this mistake.
It’s generally best to type your letter. A handwritten letter is usually acceptable, but if your writing is difficult to read, you’ll only create more problems.
Ask someone to proofread your letter for clarity, grammar and spelling. You should include any relevant documentation.
Here’s a sample letter of explanation:
Your name
Current street address
City, state, zip
Date
Re: Mortgage application (number)
Dear Mr. or Ms. (name of person requesting the letter of explanation),
This letter explains each of the items you asked about on my credit report.
- Late payment to ABC Bank (car loan) dated 12/2018
I was laid off from my job in November and unable to make my $550 car payment in December because of the drain on my finances. I did recover quickly and started a new position two months later. At that time, I made up the back payment and its associated late fees.
- Late rent payment to my landlord (Joe Smith) dated 12/2018
This payment of $1200 was also late due to my layoff in November, but three months later (on March 1, 2019) I had caught up with all my rent payments. I have started setting aside money each month into a savings account, so that I won’t be blindsided again by a job loss and will be able to keep my bills current.
I fully understand the seriousness of taking on a mortgage and plan to make all my payments in full and on time. I sincerely hope you will approve my credit application.
Sincerely,
(your signature)
What type of documentation do you need?
You should include any documentation that speaks to your case, particularly any records that corroborate your letter of explanation. Whatever you send in the way of documentation, always send copies and keep the originals.
Specific documents will vary based on your situation.
For example, if you were hospitalized and in turn defaulted on payments to creditors, you should include the hospital bills. If these bills were excessive because you didn’t have medical insurance, you’ll need to send proof that you have it now. You can also get a note from your doctor further explaining what happened. Because of HIPAA privacy laws, the underwriter can’t contact your doctor directly.
Similarly, underwriters can’t ask any questions about your health if you’re receiving Social Security Disability Income. According to the Consumer Financial Protection Bureau, unless the SSA benefit letter specifically states that benefits will expire within three years of the loan origination, lenders must treat the benefits as likely to continue.
If you experienced a gap in employment due to a layoff, include your termination letter or evidence that you received unemployment benefits.
When the issue is late or missed payments, essential documentation might include credit card or car loan statements, divorce papers or tax documents.
What to do if your letter of explanation is rejected
If the underwriter rejects your letter of explanation, it’s not necessarily the end of the line. Instead, consider submitting a new letter of explanation with more details about your finances. In some cases, the additional information will be enough to sway the underwriter.
If you still aren’t approved for the mortgage, consider looking for another mortgage lender. There may be someone out there that is willing to work with you. But unfortunately, you’ll likely run into the same approval issues with any loan officer out there.
If you decide to try a different strategy, it is time to work on resolving the issues the underwriter asked about. For example, you can work on improving your credit score or increasing your income for a better chance of approval in the future. Plus, a higher credit score could lead to lower interest rates on your loan.
Explanation letter FAQ
How do you write an explanation letter?
If you need to write an explanation letter in the home buying process, it is important to stick to the facts. Here’s what you’ll need to include: a subject line with your name and application number; your current mailing address and phone number; outline all of the facts that the lender asked you for; attach supporting documents such as bank statements, financial documents, and tax returns.
Keep the letter formal and succinct. Any lender will appreciate a prompt reply that includes all of the information they asked for clearly laid out.
What is an explanation letter for a mortgage?
A letter of explanation is a commonly requested document that provides more specific financial information about the mortgage applicant.
Typically, a mortgage lender will only request a letter of explanation if they see a concerning employment issue, derogatory marks on your credit account, too many recent credit inquiries, or have questions about your down payment funds.
Is a letter of explanation a bad thing?
A letter of explanation is not necessarily a bad thing. Although it likely means that your home loan application didn’t fly through the approval process, it does mean that the underwriter wants to learn more.
For example, in the course of the application process, a lender might ask for more information if you are self-employed. Self-employment isn’t a bad thing. It just means that the lender wants to know more about your finances.
Additional information provided in a letter of explanation, such as bank statements or the reasons behind your bad credit, could lead to the mortgage approval you’ve been looking for.
Do underwriters accept letters of explanation?
In some cases, underwriters will request letters of explanation from a potential borrower to illuminate a particular area of their financial picture.
The underwriter may want more information about any negative items on your credit report, such as a foreclosure. Or want to know more about your career if you have unexplained gaps in your employment history.
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