How to Write a Letter of Explanation for a Mortgage
When a lender asks for a letter of explanation, there’s no need to panic — more than likely they just need you to put some details about your credit, income or assets in writing. Knowing how to write a letter of explanation (LOE for short) may even help you avoid a loan denial or delayed closing.
What is a letter of explanation for a mortgage?
A letter of explanation is a written document you prepare to address questions a mortgage underwriter may have about your loan application. The letter can help strengthen the case for approving your loan application and provide evidence that your financial profile meets the lender’s minimum mortgage requirements.
For instance, a letter of explanation may provide the extra documentation needed to:
- Clear up any discrepancies on your credit report, like late payments or cosigned loans
- Verify the dates of major credit issues, like bankruptcies or foreclosures
- Help an underwriter understand how you earn money or why your income changed
- Show where your down payment or closing cost money is coming from
- Confirm whether you recently opened any new credit accounts
How to write a letter of explanation
- Step 1. Address and date the letterPlace the lender’s name, mailing address and phone number in the upper left-hand corner.
- Step 2. Create a subject lineThis line should read “RE: Your name, loan application number.”
- Step 3. Explain your financial situationExplain the issue in question and include specific details, such as names, dollar amounts, dates, account numbers and other clarification as requested.
- Step 4. Include supporting documentationIf you can, it’s helpful to give the lender evidence — for example, pay stubs, bank statements or bankruptcy paperwork.
- Step 5. Write a short conclusionThe conclusion should be courteous and indicate that you’re available to answer additional questions.
- Step 6. Sign itSign and print your full legal name exactly how it’s written on the mortgage application.
- Step 7. List your co-borrowersInclude the names of any co-borrowers who are also on the loan application.
- Step 8. Add your contact infoList your complete mailing address and phone number.
- Step 9. Let the lender know what’s enclosedIf you’re sending any supporting documentation, add an enclosure line below your conclusion and list the documents you’re including.
Mortgage letter of explanation template
Use the explanation letter sample below as a guide for your LOE:
5 tips for a good letter of explanation
- Keep it short and to the point. The mortgage underwriter is looking for clarification on a specific issue, so stick to that topic. Provide a direct answer and don’t bring up other issues that could sow new seeds of doubt. Your goal is to prove you’re capable of taking on this loan and correcting past mistakes.
- Emphasize the circumstances that led to the issue. Be sure to explain the causes of any financial difficulties that led to credit problems or gaps in employment.
- Explain how your finances have improved. Provide details about how your circumstances have changed and why the issues you’ve had are unlikely to occur again. Underwriters want reassurance that you’re ready to take on new debt, especially if you had trouble paying prior debts.
- Proofread your letter. Spelling and grammar errors can make your LOE seem less trustworthy. A typo in the loan number or accidentally using a nickname instead of your full name could result in yet another explanation letter request and delay your closing.
- Be nice. Even if you’re irritated and stressed out by the request for an LOE, the tone of your letter should be polite and professional. The underwriter is simply making sure you can afford the loan you applied for. The more helpful, respectful and prompt you are with your response, the easier it’ll be to process your loan.
When do I need to write a letter of explanation?
You only need to write a letter of explanation if your lender requests one. Common reasons why an underwriter may need additional information, over and above what you submitted with your mortgage application, include:
Credit history issues
Late payments, collections and major derogatory credit problems like foreclosures or bankruptcies almost always require a letter of explanation. Underwriters look at how you’ve managed credit in the past to determine if you can afford a new loan.
Employment history or gaps in employment
Most loan programs require a two-year employment history without gaps between jobs. A large gap may be a red flag to a lender that your income could be unstable, when in reality you may have taken time off due to a personal illness or that of a close relative. If you’ve changed careers, a lender may ask you to explain whether you’ve received any training or experience before the switch to make sure your earnings prospects are steady.
Remote work confirmation
Lenders may ask for proof your employer allows you to work remotely if you’re moving to a different city or state from where your company is headquartered. Your employer can use the same format detailed above if the lender requests an LOE directly from it.
Address history
If there’s a difference between the addresses on your driver’s license, loan application and credit report, the lender could ask for a letter to clear up the discrepancies.
Income fluctuations
Underwriters scrutinize how stable your income is, and big increases or decreases could result in a letter of explanation request. If you’re self-employed with complicated tax returns, you might even need to request a letter from your tax professional to help the lender understand how you’re paid.
Losses on your tax returns
Real estate investors, self-employed borrowers and independent contractors may show losses in the first couple of years of business. Because of this, the lender may require explanations to confirm the losses aren’t likely to continue.
Large deposits or withdrawals from your bank accounts
Transferring large sums of money (more than 50% of your normal monthly income) between bank accounts or depositing gift money from a relative for a down payment could require an LOE. Lenders may also ask for additional documentation to confirm where the deposited money came from. If you pay child support or alimony, the lender may request copies of your divorce paperwork if the withdrawals come out of your bank statements but don’t appear on your credit report.
Credit inquiries
A credit inquiry tells a lender you may have opened a new credit account, which could affect the mortgage amount you qualify for. You’ll also need proof of the new account balance and monthly payment if you open new credit that doesn’t yet appear on your credit report. Don’t forget: Lenders check your credit again before closing, so opening any new credit could lead to a last-minute loan denial.
Cosigned loans or real estate
A cosigned student loan, auto loan or mortgage will require an explanation and possibly proof that you don’t make the payments.
Relationship explanation
If you have the name of a child or parent on your bank statements, lenders may ask you to explain who they are, and even ask them to provide a letter confirming you have access to all the funds in the account. You’ll also need a gift letter that explains how you’re related to anyone giving you money toward your down payment, closing costs or mortgage reserves.
Next steps: What happens after you submit a LOE?
Once you’ve submitted your LOE, the ball is in your lender’s court. A few things could happen next:
- Requests for additional information. If the underwriter is still unclear on any details, or needs more documentation, you could be asked to send yet another letter of explanation.
- Loan approval. Well done! Your LOE satisfied the underwriter and you’re free to move ahead with your loan.
- Loan denial. If your lender rejects your application, they’ll provide you with an adverse action notice outlining the reasons for denial.
What if my letter of explanation is rejected?
You can revise the letter of explanation or create a new one that better addresses your lender’s concerns.
However, an LOE rejection could also mean it’s time to start over with a new lender or switch to a loan program, such as an FHA loan, that has more flexible requirements.
If your credit score is a sticking point, you may want to postpone your house hunt while you repair your credit.