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.
The letter of explanation may also be called an LOE or LOX.
Forms you fill out for a mortgage or refinance don’t offer space to explain what you believe may be considered a problem or you may not even be aware there is an issue. Whether you’re asked to clarify a glitch in your credit history, employment or the source for a large deposit in one of your bank accounts, this guide tells you what to do.
Why do lenders ask 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 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.
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.
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.
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.
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.
Acknowledge. 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 recommended you type your letter on the computer. 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 documentation with your letter that speaks to your case.
Here’s a sample letter:
Current street address
City, state, zip
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.
1. 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.
2. 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 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.
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.