What is a Letter of Explanation?

September 24, 2020 By

When you apply for a home loan, your Mortgage Advisor acts as the primary contact and resource for any questions you may have. However, many other departments behind the scenes will play a role in approving your loan. These departments may reach out to you during the loan process to ask for additional information or clarification.

If you faced a period of unemployment, late credit card payments, or any other financial activity that may need further explanation, you will likely be notified during the underwriting process.

Mortgage Term: An underwriter’s job is to determine how much risk the lender will assume if they loan you money to finance your home. There are specific rules and guidelines for each loan program that underwriters must ensure your information meets to confirm you’re eligible for the loan.

A Letter of Explanation

When an underwriter reviews your financial documents, they can’t always see the full picture. Whereas you may have decided to take a 2-month gap between leaving one job and starting another, all the underwriter sees is a 2-month gap in employment. This is where the letter of explanation comes in.

If an underwriter requests supplementary information from you, there’s no need to panic or assume your lender won’t be able to fund your loan. (Remember, each loan program has varying sets of rules and guidelines that you must meet to be approved.) Many of these guidelines dictate that the lender must explain certain items on borrowers’ reports. Let’s look at a few reasons why your loan may be flagged.

Income

Not every borrower has a traditional job that provides consistent income each month. If you’re self-employed or own your own business, it’s likely that you have irregular income or have had irregular income in the past. This can make loan approval complicated. In response, your lender may request a letter of explanation (with supporting documentation) detailing how you get paid and the amount you earn.

Some loan programs also require lenders to verify household income and whether all adults living in the house contribute financially. For example, if a borrower has a college-aged student living at home who doesn’t work during the school year, this may require a letter of explanation.

Large Movements Within Your Bank Account

Part of the loan approval process includes verifying that all income sources are valid. Large movements in your bank account, such as large deposits or frequent withdrawals, may require further explanation. Additionally, if a borrower plans to use gift funds toward a down payment, a letter of explanation will likely be needed to explain these funds’ sources.

Employment Gaps (or Income Changes)

Did you get laid off within the last two years? Did you decide to go back to school? How about a recent promotion or pay increase? All of these actions could raise red flags for an underwriter with no additional information. Not to worry, though, a letter of explanation detailing any changes in employment or income will help your lender verify whether or not you qualify for the loan.

Problems with Credit

Your credit score is a direct indicator of your ability to repay debt consistently and on-time. So, you can imagine why negative items on your credit report would be cause for concern to an underwriter. For example, late payments, missed payments, too many credit inquiries, or too many open lines of credit may be cause for further explanation.

How to Write a Letter of Explanation

If your Mortgage Advisor or an underwriter requests a letter of explanation, be sure to include the following information:

  • Date
  • Lender’s name, mailing address, and phone number
  • Loan number
  • Short, to the point explanation including specific details that may apply (dollar amounts, date, account numbers, etc.)
  • Signed and printed name
  • Your spouse/partner/co-borrowers name printed
  • Your complete mailing address and phone number
  • Supporting documentation

Consider using the following template:

January 1, 2020

Lending Company Name

1234 Lender Address Rd.

City, State Zip Code

(555) 123-4567

RE: John Smith, Loan Application #1234567

To whom it may concern,

I’m writing to you to explain _____________________ during the period of _______________________. This occurred because ______________________________________. Enclosed are copies of my supporting documents, including ______________________________________.

[Include full details about the employer’s name, bank’s name, account numbers, dates, etc. and state why this event should not hinder your ability to repay a home loan.] 

Thank you,

John Smith

1234 Borrower Rd.

City, State Zip Code

(555) 765-4321

 

When you’re ready to apply, we’re here to help! Connect with us today to learn more.

 

, , , ,

Categories: