During the underwriting process for a mortgage application, your lender may demand a letter of explanation from you. Writing this explanation letter for a mortgage application in 2023 may appear to be a chore, but it can clear up certain doubts about your finances and help you secure a loan more readily.
Generally, a letter of explanation is a document that explains a scenario or circumstance. There could be many reasons someone would request such a letter from you. But in any case, you must be very careful with your words.
While incorrect phrases or statements may cause problems from miscommunication, when an explanation letter is written correctly and arranged, it will help you clear yourself to the recipient.
In this article, we’ll explain letters of explanation for mortgage applications and discuss why you might need to write one.
Table of contents
- What is underwriting?
- How does a letter of explanation work?
- What’s a letter of explanation?
- Why do I need to provide a letter of explanation?
- What should my letter of explanation contain?
- How do I write a letter of explanation?
- What documents could I attach to my letter of explanation?
- What are some tips for writing this type of letter?
- FAQs on how to write an explanation letter for mortgage applications
- The bottom line
What is underwriting?
Let’s start by explaining what underwriting means. Underwriting is the stage where the mortgage company assesses if you qualify for a loan by analyzing the financial records you provided with your application, and an underwriter makes the decision.
Underwriters are finance experts who manage the underwriting process for mortgage businesses by evaluating your financial situation and determining whether you qualify for a house loan.
Sometimes, the information the underwriter is privy to may not always define your financial status. So, in cases like this, when an underwriter is unsure about something they observe, they may request a letter of explanation from you.
How does a letter of explanation work?
A letter of explanation for a mortgage application is a brief document sent to a lender. In a case like this, the lender may require you to write a letter of explanation clarifying poor credit before approving a loan.
Also, a lender may want a letter of explanation for a mortgage to give details on challenges like insufficient funds charges on your checking account.
The letter will show any fluctuations in your salary, offer your rental history, or any other reason that may require justification during the mortgage approval process.
An explanation letter can also be valuable for clarifying any conflicting information in credit reports, such as your employer’s name, current address, etc.
You can seize the opportunity then to explain yourself. These letters, as simple as they are, can be highly effective and valuable.
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What’s a letter of explanation?
A letter of explanation is a concise document that spells out everything in your financial or employment history.
The aim is to answer all parts of your finances that might cause an underwriter to hesitate, like a prior bankruptcy or if you have unexpected or sudden activity in your credit report or financial statements.
Having to write a letter of explanation does not mean that you won’t be able to get a loan. It simply means that your lender may require clarification or further information on your credit report or bank statement.
Usually, secondary authorities that own or back the debt require these letters of explanation. Such underwriting rules are imposed on lenders by the Federal Housing Administration (for FHA loans), the Department of Veterans Affairs (for VA loans), and Fannie Mae or Freddie Mac (for conventional loans).
Also, jumbo loan lenders may have more qualification requirements.
The rules often require lenders to obtain a letter of explanation for specific things on borrowers’ reports. Consider a letter of explanation request as an underwriter telling the lender, “We can see this, and we’ve reviewed it.”
Why do I need to provide a letter of explanation?
Here are some reasons you may have to write a letter of explanation:
· Your credit report has negative items
Lenders want to know that you manage your money well. Negative entries on your credit report can raise concerns for underwriters who may presume you can’t afford your bills.
In this case, you may have to write an explanation letter for any negative things on your credit report, such as skipped payments, evaded loans, or repossessions.
The letter should include a description of the unfortunate incident, its date, the creditor’s name, and your account number. It should also explain why you don’t anticipate this problem recurring.
· You haven’t paid rent before
An already existing rent or mortgage history tells a lender that you have a record of paying your housing bills on time. But if you’ve been living for free somewhere, say your parent’s house, you’ll need to show your lender a letter of explanation from the home’s owner.
The letter of explanation from the homeowner should say that you are now living in their home rent-free and indicate how long you have been there. Ensure that they sign and date the letter correctly.
· You have income or loss from a farm property
The principal basis for determining the value of a house is not on another structure on the property. So, if an income or loss from a farm is on Schedule F of your income tax returns, you must present a letter stating that the farm is not on the land you’re purchasing.
It must also mention the farm address associated with the revenue or loss, as the underwriter cannot obtain this information from your tax filings.
· There are extended periods of unemployment in your history
To pay a home loan, you need a consistent and stable income. So, extended periods of unemployment do not help your credibility or reliability.
Your lender will likely request a letter of explanation for pauses in employment within the last two years, especially for VA and jumbo loans. A letter is only necessary if the gaps exceed 30 or 60 days, depending on the type of loan.
You will have to give your reason for the gaps. Reasons from having a kid to returning to school, caring for a family member, a business collapse, downsizing, widespread layoffs due to the COVID-19 epidemic, seasonal jobs, and more are standard.
You should also include details on how you were able to continue meeting your financial obligations during this time.
What should my letter of explanation contain?
Request for explanation letters is one of the mortgage application processes. Make sure that your letter of explanation has the following information:
- The date you write the letter
- Your lender’s name
- Lender’s contact details, including mailing address and phone number
- A subject line beginning with “RE:” and followed by your name, application number, or other identifying information
- One or more paragraphs containing detailed information the lender requested, like dates, dollar amounts, account numbers, etc.
- Other documents that identify and support your claims (copies of bills of sale, title transfers, marriage licenses, etc.)
- Your full legal name, signed and printed, as it is on your mortgage application,
- A partner’s name, if they are also on the loan application,
- Your complete mailing address plus a 10-digit phone number
- And a polite closing
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How do I write a letter of explanation?
When most people have to write an explanation letter for an underwriter or loan officer, they have no idea how to begin or why it is necessary.
However, writing letters of explanation provides an essential piece of supporting documentation for a regular mortgage application in 2023. So, you should ensure that your letter is detailed and accurate.
You should also attach supporting documents to your letter for more credibility. For example, suppose the underwriter inquires why your account was credited with a significant amount.
In that case, you can state how you got the money and attach receipts or other paperwork supporting your reason.
Sometimes, the explanation letter can also be a form of sworn testimony. So if you have a misplaced or destroyed sales receipt, some banks will accept your formal explanation letter as an alternative.
You can make deposits, explain contradictory information, and explain circumstances such as bankruptcies or late payments with an explanation letter in 2023.
What documents could I attach to my letter of explanation?
Getting a request from an underwriter for an explanation letter for your mortgage application should not alarm or scare you.
Remember that the letter is just requested so that you can explain any unexpected situations or concerns in your loan application, plus it is not stressful to write.
You only need to explain the question posed, and that’s it. In some situations, you should attach documentation to the letter at your underwriter’s request. These documents may include the following:
However, remember that underwriters are not permitted to request a letter from your doctor due to privacy rules.
What are some tips for writing this type of letter?
Start the explanation letter with the date, followed by a salutation and an explanation of the incident or situation. Be as descriptive as possible while composing the letter, and use actual monetary numbers and dates to bolster your clarifications if necessary.
For example, if you’re explaining a financial problem, outline all your efforts to ensure the situation doesn’t reoccur.
Either way, note that you should always present accurate and factual information. Otherwise, you risk getting in trouble if they discover that the contents of your letter are false.
Remember that although this form of the letter can assist lenders in making a favourable decision for you, it will not be the deciding factor.
However, it can help lenders decide whether or not to approve your application after understanding your financial picture. If you have any queries concerning the requirements or the necessity for the letter, you can seek advice from a Loan Officer at your bank.
Don’t make the letter overly long. Typically, a couple of phrases will do to convey your message. You are also not required to supply further information beyond what they requested.
There are no “correct” or “incorrect” formats or responses for the letter. It’s simply an explanation of their request. So you don’t have to invent anything to make your letter perfect.
Be courteous but not overly friendly, and avoid emotional words.
After drafting the letter, check it over for typos and grammatical errors. Send the letter as soon as possible to keep your mortgage application on schedule.
Also Read: How to Write a Dispute Letter Templates | Full Guide
FAQs on how to write an explanation letter for mortgage applications
To write an explanation letter for mortgage applications:
Start with the date, followed by a salutation and an explanation of the incident or situation.
Give a brief but detailed description without needless phrases.
Explain the measures you took to correct the error or fill in the missing information.
Using facts, highlight your existing situation and explain the probable conclusion after you’ve solved the problem.
Provide only accurate and factual information.
You may have to attach the following documents to your explanation letter:
A copy of your hospital bill if you have been out from work for an extended period
A copy of the obituary if you have been absent from work due to a death in your family.
If the significant deposit in your account was an inheritance from a relative, provide a copy of the cheque.
Here are some reasons you may have to write a letter of explanation:
Your credit report has negative items
You haven’t paid rent before
You have income or loss from a farm property
There are extended periods of unemployment in your history
The bottom line
A lender would want to ensure you’re in the best financial position to take on the financial obligation of a mortgage and that they’re making a wise investment.
So, even when certain factors may raise a red flag for the underwriter, your lender may request a letter of explanation to relieve worries.
You (or a third party) may need to write an explanation letter for a mortgage application in 2023 for many reasons depending on the lender and the type of loan you’re seeking.
When you request an explanation letter, you should follow our tips and steps to write an effective explanation letter.
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