A mortgage letter of explanation is a document that borrowers send to loan officers or underwriters to explain areas of concern in their mortgage application.
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.
What is a letter of explanation?
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.
What is underwriting?
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.
What needs to be addressed in a letter of explanation?
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:
Negative credit report
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.
|Credit score||APR||Monthly payment||Total interest paid|
|760 - 850||6.129%||$304||$59,416|
|700 - 759||6.351%||$311||$62,014|
|680 - 699||6.528%||$317||$64,104|
|660 - 679||6.742%||$324||$66,652|
|640 - 659||7.172%||$338||$71,841|
|620 - 639||7.718%||$357||$78,556|
|*Rates above for a $50,000 30-year fixed rate mortgage.|
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.
Large withdrawals and/or deposits
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.
Losses on tax returns
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.
Tips for writing a good letter of explanation
Putting together an effective letter of explanation may seem overwhelming at first, but there are three base elements to include that can make the process more approachable.
- Facts. Lay out the facts (briefly) for each item in your letter. Be honest! It’s not advisable to write your letter based on what you think will appeal to lenders rather than the facts. Double-check all the facts you provide to avoid bigger problems down the road.
- Resolution. Clearly explain how each item in your letter was resolved. If your income significantly decreased from one year to the next, show how you handled that change and how it won’t affect your ability to repay the loan.
- Acknowledgment. In addition to explaining how an issue in your finances was resolved, your mortgage lender wants you to show them that the same problem won’t arise again in the course of repaying your loan. Demonstrating how the problem was addressed in as much detail as possible and how it will be prevented in the future is how you assure lenders that you are a good candidate for a loan.
Professionalism and supporting documentation
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.
Explanation letter template
[lender’s mailing address]
RE: [property address or loan number]
To Whom It May Concern,
I am writing to you to explain the gap in my employment between March 12th, 2022, and May 23rd, 2022.
During this period, I spent the majority of my time caring for my elderly father, who struggles with dementia. This gap allowed me to care for him as I looked for a proper nursing home to care for him. Since submitting my loan application, I have found employment for XYZ Company, Inc. as a software engineer. Please find a photocopy of my offer letter and two most recent paychecks enclosed for your records.
Please let me know if you require any further clarification or information regarding my loan application.
[your current mailing address]
[your phone number]
What happens after you send a letter of explanation?
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.
Do I need a letter of explanation?
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.
- A mortgage letter of explanation helps put your financial situation in context so lenders and underwriters have the whole picture when reviewing your application.
- Underwriting is the process by which lenders review loan applications to decide whether someone is a good candidate to receive a mortgage loan.
- Honesty and brevity are important in writing letters of explanation, so keep your letter truthful, short, and to the point.
- Underwriters look for a few key elements in letters of explanation, including facts, resolution, and acknowledgment of the issue.
View Article Sources
- Mortgagee Letter 2013-24 — U.S. Department of Housing and Urban Development
- Get a prequalification or preapproval letter — Consumer Financial Protection Bureau
- How Often Does an Underwriter Deny a Loan? — SuperMoney
- Confused About Different Mortgage Types? Here’s How to Choose the Right One For You — SuperMoney
- What Is a Mortgage Constant and How to Calculate It? — SuperMoney
- Mortgage Loan Originators: Who Are They & What Do They Do? — SuperMoney
- What Is a Mortgage Origination Fee and How to Avoid Them? — SuperMoney
- What Is a Graduated Payment Mortgage? — SuperMoney
- Mortgage Broker Fees: The Complete Guide — SuperMoney
- Buying a House? Here’s How to Choose the Best Mortgage Lender — SuperMoney
- How to Finance a House — SuperMoney
- How to Buy a House — SuperMoney
- Veterans United Home Loans Mortgage — SuperMoney