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Letter Of Explanation: Why You May Need One When Applying For A Mortgage

When applying for a mortgage, you may be required to provide a letter of explanation for certain aspects of your financial or employment history. A letter of explanation refers to a brief document that can help clarify any unusual or sudden activity in your credit report or bank statements or provide additional information about long gaps in your employment history, negative items on your credit report, or living rent-free. It is a tool that can help demonstrate to the underwriter that you are a qualified buyer and increase your chances of getting approved for a mortgage. In this article, we'll go over some common reasons why you may need to provide a letter of explanation and how to write one effectively.

The Basics Of Underwriting

Underwriters are finance professionals who oversee underwriting and assess your finances to determine whether you're a good candidate for a home loan. Ultimately, underwriting is a crucial stage in the mortgage process that helps protect both the borrower and the lender. To understand underwriting , the mortgage company evaluates your financial information when determining whether you are qualified for a loan. You may need to provide additional information to the underwriter if the information provided only tells part of the story. In this way, you are sure that the lender is making a sound decision and that you can afford the loan.

What Is A Letter Of Explanation?

Your credit score will decrease when you obtain credit, make overdrafts, pay late, make large deposits, or withdraw money from your checking or other bank accounts. A letter of explanation is necessary if any sudden or unusual changes occur in your financial or employment documents, which may cause an underwriter to pause. Lenders often require these letters for FHA loans, VA loans, and conventional loans supported by Fannie Mae or Freddie Mac as part of their underwriting standards. Jumbo loan lenders may also have additional qualification standards.

Obtaining a letter of explanation may mean that the loan application will be approved. Most of the time, lenders only need clarification or more information about your financial history.

You can also use a letter of explanation to determine how much house you can reasonably afford, which will streamline your search and help you get into your new home faster. You can improve your chances of securing a mortgage loan by explaining any potential red flags in your financial history.

Suppose you need to provide a letter of explanation. In that case, being honest and transparent about your financial history is crucial. Be sure to provide all relevant information and documentation to support your explanation, and be ready to answer any follow-up questions the lender may have. By working closely with your lender and explaining potential issues, you can help ensure a smoother and more successful mortgage application process.

Why Providing A Letter Of Explanation Matters In Your Mortgage Application

It is a written statement explaining specific details in your financial history that could affect your ability to secure a home loan. When applying for a mortgage, there may be instances where you will be required to provide a letter of explanation. The following reasons may warrant a letter of explanation, along with what to include:

Negative Items on Your Credit Report

Credit reports  are essential tools for lenders to assess your creditworthiness. Missed payments, defaults, foreclosures, or repossessions on your credit report can raise red flags for underwriters who may doubt your ability to repay debts. Negative items on your credit report may require a letter of explanation. The letter should include the event date, the creditor's name, and your account number. Additionally, explain why you do not expect this problem to happen again.

Living Rent-Free

Rent or mortgage payment history is crucial for lenders to determine whether you can handle housing costs. When living rent-free with your parents or another relative, you must prove this to your lender with a letter from the property owner. The homeowner should indicate how long you have lived in their home rent-free and sign and date the letter.

Income or Loss from a Farm Property

A letter of explanation may be required if you have income or losses from a farm property listed on Schedule F. Lenders cannot finance a farm property. They need to know that another structure on the property is not the primary reason for the property's value. Your letter should state that the farm is not on the property you are purchasing and include the farm's address related to the income or loss.

Long Gaps in Your Employment History

Long gaps in employment history  can make you appear like a riskier client to lenders. If you have gaps in unemployment within the last two years, your lender may require a letter of explanation for VA and jumbo loans. Your letter should explain what occurred during the gap and include the duration the gap lasted, whether it was greater than 30 or 60 days, based on the type of loan. Some reasons for gaps could be having a child, returning to education, caring for a family member, downsizing, business failure, COVID-19 pandemic layoffs, self-employment, or seasonal work. Include information if you managed to meet financial obligations during that time.

Tips for Writing an Effective Letter of Explanation for Your Mortgage Application

When submitting a letter of explanation, it's essential to follow the format of a traditional business letter, whether you're sending it via mail or email. It includes:

  • The lender's name and address
  • Your name (as stated in your application) and any client/reference/file number
  • The date of submission and the expected closing date (if known)
  • A brief introduction that identifies the topic being discussed
  • Email address, phone number, and mailing address

Don't panic if a lender requests a letter of explanation. Follow these three steps to provide strong support for your application:

Be Honest

When writing a letter of explanation, it is crucial to be transparent. If your lender requires you to submit a letter of explanation, you must be truthful. Lenders appreciate honesty and are more inclined to approve your application if they believe you are trustworthy. Be honest, but stick to the facts. Avoid embellishing or exaggerating your circumstances.

Be Brief

Keep your letter concise and focused only on the details that must be covered. Remember, there's no need to write a novel. Lenders process loads of applications, and lengthy letters can make their jobs more challenging. Rather than wasting time on irrelevant information, concentrate on the details needed to move your application along.

Be Business-like

Maintain a high level of formality throughout your letter. Make sure that your letter is well-written and free of grammatical errors. Proofread your letter and double-check your spelling, capitalization, and business-like composition. It's important to remember that this letter isn't the same as a casual email or chat message you send to your colleague about lunch. Your future as a homeowner lies in the hands of the recipient.

Template for Writing a Letter of Explanation to a Mortgage Lender

If you need to write a letter of explanation to a mortgage lender, here is a sample template you can use to guide you:


[Lender name]

[Lender address]

[Lender city, state, and ZIP Code]

RE: [Your Name] and [Application Number]

Dear Loan Specialist,

I am writing to explain that I did not receive payroll deposits for January and February in my [bank name] checking account.

During those two months, I had to take an unpaid medical leave of absence from my employer under the Family and Medical Leave Act (FMLA) due to complications arising from my son's birth. I have since returned to work and am now in my previous position and receiving full pay. I have attached a letter from my employer, [its name], verifying my active status, return date, and salary.

Feel free to ask me any further questions. I am available to provide additional information or documentation to support my application. I am looking forward to our expected closing date of May 30.


[Your Name]

[Your Mailing Address]

[Your City, State, and ZIP Code]

[Your Phone Number]

If you have a co-signer , write their name on the letter as well.

Remember that supporting data and paperwork can make your letter of explanation more compelling. According to the example above, the borrower included a letter from their employer confirming their return to work.

If you have any documentation supporting your claim, consider including it with your letter. Providing additional information or documentation can strengthen your case and increase your chances of getting approved.

The Bottom Line: Explanation Letters Can Boost Your Mortgage Approval Chances

Mortgage lenders must ensure that you're financially capable of taking on a mortgage and that they're making a wise investment. Certain things, however, can raise a red flag for the underwriter, prompting them to request a letter of explanation. The lender may require this letter or a third party, depending on what type of loan you're getting. It's advisable to prepare a letter of explanation in advance if you've experienced any situations that may require one. Doing so can ensure a smooth mortgage process and increase your chances of getting approved.

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