How To Write a Mortgage Letter Of Explanation: Template Included

As anyone with a property can tell you, the home-buying process is long and complicated. Not only can the process of finding a house be difficult, but preparing your financial statements and paperwork for mortgage lenders can also be a hassle.

Because a house isn’t a small purchase, mortgage lenders need to make sure applicants can handle the financial responsibility of owning a home. This means lots of close analysis of employment, income, and bank account statements. So what can you do if your application looks bad but actually isn’t?

This is where a letter of explanation comes in. Keep reading to learn what a letter of explanation is, what it could mean for your application, and the “dos” and “don’ts” of writing your letter.

A letter of explanation is included in your mortgage application to help clarify inconsistencies or gaps in your financial records or credit history that may be concerning to mortgage lenders. This, hopefully, will give you a better chance of being approved for a home loan. Essentially, you’re submitting a written record that puts your credit report and overall finances in context.

By including a written explanation as to why your financial situation looks the way it does, you can help assure lenders that you are a good candidate for a home loan (even if your financial history has some blemishes). Letters of explanation can make the difference between a lender approving or denying a loan, so it’s vital that your letter is thorough and clear.

Lenders check your explanation letter for a few key elements, which you’ll want to make sure and include to put yourself in the best possible position for loan approval.

Underwriting is part of the mortgage application process where mortgage lenders determine whether you qualify for a loan by reviewing your financial information. When you submit an application for a loan, you must include a number of documents and records to show the mortgage lender why you’re a good candidate for that loan. Lenders use underwriters or loan officers to review your information and ultimately decide whether to approve or deny your loan.

“An underwriter is a professional who evaluates the risk associated with lending money to a borrower,” says Min Hwan Ahn, an immigration attorney. “They review the loan application, credit report, and other financial information to determine whether the borrower is a good risk for the lender. The underwriter’s job is to ensure that the loan meets the lender’s standards and guidelines, and that the borrower has the ability to repay the loan.”

The information you provide in your loan application might not always show your whole financial picture, so letters of explanation are used to, well, explain why your finances look the way they do. An underwriter or loan officer needs to see the reasons, in writing, for your financial history to help give you the best possible chance of mortgage approval.

Letters of explanation contain short descriptions of potentially concerning pieces of your loan application. You can think of it as filling in the gaps where a loan processor may ask questions.

Keeping each description brief and concise is crucial, as lenders are already reviewing your application and may not want to read a lengthy letter in addition to other documents. If possible, provide additional documentation to clarify the points in your letter, which can help speed your application review along.

Here are some common issues to cover in a letter of explanation:

A key element in any mortgage application is demonstrating how you manage your credit. Things like bankruptcies, overdraft fees, missed payments, late payments, and foreclosures in your credit history are, obviously, concerning for lenders. To help your application, briefly explaining why those are part of your credit report should be a top priority in your letter of explanation.

However, sometimes it’s better to wait and repair your credit score before applying for a home loan. After all, a poor credit score may cost you so much in interest that building up your credit report and score is worth it.

If you need some help repairing your score or find some fraudulent information on your credit report, you may want to hire a credit repair company.

Most loans have minimum employment requirements, including max periods of time between jobs. Big gaps in employment set off alarm bells for lenders because it could mean that you don’t have sufficient income to pay back your loan.

If your employment history has big gaps in it due to illness, family emergencies, or any other exigent circumstance, explaining that in your letter will set lenders’ minds at ease when reviewing your application. That said, make sure you have some form of steady income by the time you apply for the loan.

Similar to showing a satisfactory employment history, mortgage lenders want to make sure your income level is stable for a minimum period of time. You’ll likely have to provide pay stubs or bank statements in your application, which lenders check for consistency.

Drastic changes in how much you make per year require a good explanation in your letter so lenders aren’t worried about your ability to repay a loan.

Transferring more than 50% of your monthly income between bank accounts can catch the attention of lenders.

Explaining why you moved so much money between bank or credit accounts and where that money came from are good places to start in your explanation letter. This is especially true if the money is borrowed from a family member or another source.

If you just started a new business, are self-employed, or recently began investing in real estate, chances are you’ve shown losses on your tax returns in the last one to two years. Those losses will show up on the tax documents you submit with your application.

Lenders want to make sure that those losses aren’t a pattern, so clearing up any confusion about those in your letter of explanation is a smart bet.

This one is easy to forget about, so make sure you explain the address discrepancy if your address is different between your financial documents and your identifying information.

While not an official element in a letter of explanation, writing in a professional manner preserves your credibility with lenders. Double-checking for proper grammar, punctuation, formality, and spelling prevents underwriters from getting distracted while reading your letter. In addition, careful proofreading demonstrates that you pay attention to detail and are competent when handling your finances.

Providing supporting documents can help streamline the application review process. If the lender requests further information or clarification, respond promptly and transparently to demonstrate your reliability. This helps streamline the application review process. If your lender requests even more information or clarification, provide them with a direct answer to every question (if you haven’t already). Lenders are looking for reliability in loan candidates, so showing transparency is to your advantage.

Proper formatting matters as well. For help with putting a professional-looking letter of explanation together, follow our sample letter.

Once you send your letter, along with your loan application and financial records, an underwriter will review your financial history and letter to decide if you are a good candidate for a home loan. Unless the underwriter needs something else from you, it’s essentially a waiting game from this point on. You’ll wait to hear back one way or another from your lender as to whether you’re approved for a loan.

Ideally, you include your letter of explanation along with all your application documents and records so that your lender doesn’t have to ask you for it a few days later. Even better, you address every possible concern in your letter all at once so your application can be processed and approved quickly.

You may need a letter of explanation if there’s anything in your loan application or financial history that you think will catch the attention of a lender. As mentioned above, common reasons to send a letter of explanation include negative credit reports, lengthy gaps in employment, or unusually large deposits or withdrawals. Basically, if you think a mortgage lender will ask you about it, go ahead and send a letter explaining it.