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This blog post will help you figure out what an explanatory letter is, why it’s important, and how to write one.
What are letters of explanation for a mortgage?
A letter of explanation may be used to clarify anything in your financial or employment paperwork that might cause an underwriter to pause. For example, if you have unusual or rapid changes in your credit report or bank statements, you may be required to write a letter of explanation.
Don’t assume that your lender can’t provide you with a mortgage loan if they need one of these letters. The situation is frequently the opposite. They may just want further details about your credit report or bank statement, for example.
Why do lenders ask for explanations?
Letters of explanation are frequently required by secondary authorities who own or back the loan. The Federal Housing Administration (for FHA loans), Department of Veterans Affairs (for VA loans), and Fannie Mae or Freddie Mac (for conventional loans) impose such underwriting standards on lenders. Furthermore, lenders that provide jumbo loans may impose stricter qualifications.
Many of these rules state that the lender must obtain a letter of explanation for certain items on the borrower’s credit report. Consider a request for a letter of explanation to be an underwriter’s way of informing the lender, “We understand this item is here, and we’ve investigated it.”
Differences in addresses.
The lender may also request letters of explanation if the borrower lives in a different part of the country. For example, if you have lived or worked for several years in New York City and are applying for a mortgage loan in Chicago, your lender may ask for an employment letter to explain why you didn’t transfer your New York state driver’s license.
You will need to provide your correct mailing address to satisfy the underwriter’s request.
You may be asked to write a letter of explanation if your income is erratic. For example, if you receive a big bonus from work, and have a large deposit into your account. Or another example is a salesperson who earns commission and has varying deposits.
You may also be asked to write a letter of explanation if you have diverse circumstances. This generally means any special circumstances that are not reflected in your credit report or employment history.
Large deposits in one of your accounts.
If you have one or more bank accounts with a large deposit that is different from your other bank account balances, your lender may ask for a letter of explanation. You may need to show pay stubs or other documentation explaining the large dollar amounts.
Late or missing payments.
If you have a late payment that is late or missing from your credit report, your lender may ask for a letter of explanation to explain the delinquencies. Late Payments are generally considered as red flags. Your letter needs to explain the situation
Interruption in employment.
If you’ve had an interruption in employment, your lender may ask for a letter of explanation. Things such as layoffs or work stoppages happen. Your lender may also ask for a letter of explanation if you’ve had an interruption in employment because you’ve started your own business.
Too many credit inquiries.
If you have too many credit inquiries in a short period of time, your lender may ask for an explanation. These credit inquiries usually stay on your credit report for 2 years.
If you’re self-employed, your lender may ask for a letter of explanation about your income. This is because self-employment income can be difficult to verify. The underwriting team will likely ask for tax returns and financial documents. And additionally for all the specific details in your supporting documents.
If you have a co-borrower, but the property will only be in your name, your lender may ask for a letter of explanation from you to explain why there’s a co-borrower on the loan. Situations like this are not always legal, but a loan officer can help you understand the process.
During the application process, the lender will attempt to verify all the information you are providing. This usually includes reviewing your bank account. Your bank account can be used to verify income, assets, and liabilities.
Many lenders ask you to provide the necessary documentation for them to be able to view your bank statement online. If they ask for this information, simply follow their instructions on how to send it. Remember that what you put in here will reflect on the final product so be truthful.
The underwriter may also request a letter of explanation if there are large deposits or withdrawals that are not consistent with the rest of your banking history.
Be sure to provide accurate and up-to-date contact information in case the lender has any questions while they are reviewing your application.
If you and your spouse have a joint account the lenders will want to review the financial history there also.
Mortgage lenders pay special attention to your credit score. As part of the underwriting process to gain as much relevant information as possible.
The lender will request your credit report. Your credit score tells them how likely you are to repay money that is lent to you. Lenders use this information to determine whether or not they should lend money for a property and what interest rate to charge you.
They will review for red flags. Like missed payments, credit reports, and correct dates.
We recommend obtaining a credit report before starting the mortgage process. And specifically, look for discrepancies, like accounts that are still open when you thought they were closed.
If there’s any inconsistency, be sure to clear it up before submitting your application or the lender may ask for a letter of explanation.
Lenders will want to review the information in your credit report to make sure it matches what you’re saying during the underwriting process.
The first and most important step in keeping your credit score high is to keep up with all your bills. And repay any debts you owe. This includes medical bills, credit card bills, and other loans.
Some people find that the hardest part of staying on top of their bills is remembering what they owe and when.
One Free tool we recommend is Wallethub. Knowing your credit information can help you while house hunting, and applying for a loan.
Another free tool is Mint. Mint is a tool to connect all your accounts. You can track your bills, know your balance (and avoid overdraft fees), and keep track of tax documents.
How to write a letter of explanation for your mortgage lender?
You don’t have to be concerned if your lender asks for a letter of explanation. These letters are quite usual in mortgage applications.
The following are the key aspects that your letter should include:
Include as much detail with correct dates and dollar amounts, and anything else the lender requests.
Explain how and when the situation was resolved. Cover all the questions the lender asked.
It’s critical to explain why the problem won’t occur again in your letter. Recognize and analyze whether and how you may have prevented this blunder.
Here’s a sample letter:
Current street address
City, state, zip
Subject line: Mortgage application (loan application number)
Dear Loan Specialist,
This letter explains each of the items you asked about on my credit report.
1. On December 12, 2018, I made a late payment to ABC Bank (auto loan).
In November, I was let go from my employment and was unable to make my $550 automobile payment in December due to the strain on my funds. I bounced back quickly and found a new career two months later. At that point, I made up for the missed payments and late fees.
2. Different addresses listed on my driver’s license and my current mailing address.
I recently changed my mailing address to a post office box. This is because I intend to move as soon as the loan closes. And even though I am aware that the post-service can forward the mail, I wanted to be sure no additional trouble managing the documentation.
This is the reason for my address discrepancy.
I fully understand the seriousness of taking on a mortgage and plan to make all my payments in full and on time. My hope is that you will approve my credit application. Find attached supporting documentation in this explanation letter.
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.
What if my lender rejects my letter of explanation?
It’s best to research your lender beforehand and find out whether or not they will accept a letter of explanation.
If your lender does reject your letter, ask them for feedback on how to improve it. Also, ask if there is any additional documentation needed for your loan file. Then submit a new letter with your account numbers and financial situation. They may be more likely to approve it.
Compare multiple lenders
The final option is to seek a different lender. You can ask what interest rates they offer. And what the underwriting requirements are for their loan application.
You may be able to get a better rate with a different lender.
Your credit information can help you while house shopping and applying for a loan. Another free tool is Mint. Mint is a tool to connect all your accounts. You can track your bills, know your balance (and avoid overdraft fees), and keep track
What is a letter of explanation for credit inquiries?
A letter of explanation for credit inquiries is a letter written to a creditor to provide an explanation for why there were multiple hard inquiries on your credit report. You should send this letter if you have been denied credit or if the creditor is considering lowering your credit limit because of the number of inquiries on your report.
Is a letter of explanation for mortgage bad?
No, a letter of explanation for a mortgage is not bad. A letter of explanation serves as a formal way to communicate with your lender and provide them with an understanding of your credit history. It can also be helpful in explaining any blunders on your credit report. If you have been denied credit or if the creditor is considering lowering your credit limit because of the number of inquiries on your report, you should send this letter.
Why do underwriters ask for letters of explanation?
Lenders often ask for letters of explanation to better understand the financial situation of the borrower. Letters of explanation can also be used for requests that extend beyond what is offered on your credit reports, such as a request for rental history or pay stubs. Some lenders only accept letters of explanation if they are asking for information that is not available on your credit report.