Explanation Letters And Your Mortgage Application: Why They’re Important And How To Write One


Your lender might ask you for a letter of explanation during the underwriting process. A letter of explanation consists of short descriptions you can use to fill in the gaps in your paperwork for your underwriter. Letters of explanation might sound like a pain to write, but the truth is that they can actually help you get a loan more easily.

We’ll explain what letters of explanation are and why you might need to write one. We’ll also give you a sample template you can use to draft your own.

The Basics Of Underwriting

First, let's go over what exactly underwriting is. During the underwriting stage of a mortgage, the mortgage company decides whether you qualify for a loan by reviewing the financial documents you submitted with your application.

Mortgage companies use finance professionals called underwriters to oversee underwriting. An underwriter’s job is to assess your financials and decide whether you’re a good candidate for a home loan.

The information the underwriter sees doesn't always tell your entire financial story. An underwriter may request a letter of explanation from you if they’re unsure about something they see.


What’s A Letter Of Explanation?

A letter of explanation is a brief document you can use to explain anything in your financial or employment documents that might make an underwriter pause, like a previous bankruptcy. For example, you may need to write a letter of explanation if you have unusual or sudden activity in your credit report or banking statements.

Don’t assume your lender won’t be able to give you a loan if they need one of these letters – the opposite is often true. They might simply need clarification or more information about your credit report or bank statement.

Letters of explanation are requirements from secondary authorities that own or back the loan in many cases. 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 offer jumbo loans may have additional qualification standards.

Many of these guidelines dictate that the lender must get a letter of explanation for certain items on borrowers’ reports. Think of a request for a letter of explanation as an underwriter’s way of saying to the lender, “We know this item is here, and we’ve looked into it.”

Why Do I Need To Provide A Letter Of Explanation?

The following are examples of reasons you may be required to provide a letter of explanation.

There Are Negative Items On Your Credit Report

Lenders need to know you have no trouble managing your finances. Negative items on your credit report can set off red flags for underwriters who might assume you have difficulty paying your bills. You may need to provide a letter of explanation for any negative items on your credit report, including missed payments, defaulted loans or repossessions.

The letter should include an explanation regarding the negative event, the date it happened, the name of the creditor and your account number. It should also include an explanation of why you don’t see this problem happening again.

You’re Living Rent-Free

Rent or mortgage history shows a lender that you’re capable of paying your housing costs on time. If you’ve been living for free somewhere, for example at your parent’s home, you’ll need to prove that to your lender with a letter of explanation from the owner of the home, not you.

In the letter, the homeowner should state that you’re currently living in their home rent-free and indicate how long you’ve been doing so. Make sure they also sign and date the letter.

You Have Income Or Loss From A Farm Property

When it comes to determining the value of the home, another structure on the property cannot be the primary reason for that value. Along with that, some lenders, including Rocket Mortgage®, do not finance farms.

If you have an income or loss from a farm property listed on Schedule F of your income tax returns, you must produce a letter of explanation that states the farm is not on the property you’re buying. It must also include the address of the farm that’s tied to the income or loss since the underwriter cannot get this information from your tax documents.

There Are Long Gaps In Your Employment History

You need a steady and reliable income to keep up with a home loan, so long gaps in unemployment may make you seem like a riskier client. For VA and jumbo loans, your lender may require a letter of explanation for gaps in unemployment within the last 2 years. A letter is only required when said gaps are greater than 30 or 60 days, depending on the type of loan.

You’ll need to explain what occurred as there are many reasons for such gaps, including having a child, a return to education, caring for a family member, a business failure, downsizing, mass layoffs due to the COVID-19 pandemic, seasonal work and more. If you were able to continue meeting your financial obligations during this time, include that information, too.

How To Write A Letter Of Explanation

Letters of explanation are a common part of the mortgage application process. Make sure your letter of explanation includes:

  • The current date (the day you write the letter)
  • The name of your lender
  • Your lender’s complete mailing address and phone number
  • A subject line that begins with “RE:” and includes your name, application number or other identifying information
  • One or more paragraphs that provide information the lender asked for. Be as detailed as possible and include dates, dollar amounts, account numbers, etc.
  • Any supporting documents that provide identification and back up your claims (copies of bills of sale, title transfers, marriage licenses, etc.)
  • Your full legal name as it appears on your mortgage application, signed and printed
  • Your spouse or partner’s name if they’re on the loan application with you
  • Your full mailing address and 10-digit phone number
  • A polite closing

The key to writing a great letter of explanation is to keep it short, simple and informative. Be clear and write with as much detail as you can since someone else will need to understand your situation. Avoid including irrelevant information or answers to questions the underwriter didn’t ask. Be polite, but not overly friendly, and don’t use emotional language.

After you finish writing the letter, edit for typos or grammatical errors. Send the letter in a timely manner to keep your mortgage application on track.

Explanation Letter Template

Here’s a sample letter of explanation. You can use it as a template when you write your own letter.

July 15, 2021

Sample Lending Company

123 Lending Lane

Brooklyn, NY 11207

000-000-0000

RE: Jessica Smith’s Mortgage Loan Application

To Whom It May Concern:

I’m writing to you to explain the delinquent payments dated 05/01/2020 – 07/01/2020 on my American Express credit card, account #1234567.

On April 15, 2020, I was laid off from my job due to the COVID-19 pandemic. Because I was unemployed, I was unable to make my minimum credit card payments for this account for May and June. I got a new job on June 20, 2020 and was able to make my July payment.

I am still working at the same company today and, since July 1, 2020, I have not been late on, nor missed, any payment on this credit card account. Enclosed is a copy of my statements from July 1, 2020 until now as proof of my good standing and on-time payments with this account.

Sincerely,

Jessica Smith

150 Same Drive

Brooklyn, NY 11207

000-000-0000

The Bottom Line: Explanation Letters Can Help Increase Your Chances Of Mortgage Approval

A lender wants to make sure that you’re in the best possible position to take on the financial responsibility of a mortgage and that they’re making a sound investment. There may be certain things that can trigger a red flag for the underwriter, so your lender may ask you for a letter of explanation to help ease concerns.

There are a few reasons you or a third party may need to produce this letter and they depend on the lender you’re working with and the type of loan you’re getting. If you have experienced any of the examples above, you may want to prepare a letter of explanation now to ensure a smooth process.

Providing an explanation letter is just one piece of the underwriting process. If you’re curious about how long the entire procedure will take, check out Rocket Mortgage’s article detailing the full timeline from underwriting to closing.


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