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As part of the mortgage lending process, you may need to write a letter of explanation to clarify past negative items or gaps in your financial history or credit report.
Buying a home is an exciting experience, and you don’t need an amazing credit score to get a home loan. In fact, you can have a minimum score of 580 and get approved for a loan. However, when you have a low credit score or items on your credit report that are a red flag to lenders, you may need to write a letter of explanation.
Knowing how to write a letter of explanation is important if you hope to acquire a loan for a house, as the document provides clarification about your credit report or bank statement and can help you get approved by lenders. In this article, we’ll cover the details that go into this letter, and you’ll walk away with a better understanding of the underwriting process and why you may need a letter of explanation. We’ve also provided a free letter of explanation template that you can download to make the process easier.
Table of contents
- What is a letter of explanation?
- Why do I need a letter of explanation for a mortgage?
- How to write a letter of explanation
- Letter of explanation example
- Free letter of explanation template
- FAQ
What is a letter of explanation?
A mortgage underwriter may request a letter of explanation to get additional details about your financial situation. During the home-buying process, an underwriter will go through your finances with a fine-tooth comb. If there are gaps in your employment history, inconsistent income or other situations that fall into this category, they’ll have questions that can be answered with a letter of explanation.
The requirements for letters of explanation come from secondary authorities that often back the home loan, including:
- Fannie Mae and Freddie Mac
- The Department of Veterans Affairs (VA)
- The Federal Housing Administration (FHA)
These organizations offer FHA, VA and conventional loans. There are other lenders that deal with jumbo loans and have additional standards for qualification for a home loan. Lenders require letters of explanation as a way to ensure a borrower is able to pay their mortgage.
What does an underwriter do?
An underwriter is a finance professional who works with or for mortgage companies to assess your finances when you apply for a home loan. They may be interested in both your current financial situation and your financial history. Their review of your financial information allows them to provide the mortgage company with a better idea of whether or not they should provide you with a home loan.
An underwriter will look at your:
- Income
- Property
- Assets
- Bank statements
- Credit score
- Credit report
- Debt-to-income (DTI) ratio
These documents provide quite a bit of information, but the underwriter may still have questions. From here, they’ll request additional information like a letter of credit explanation, which is a specific letter explaining something on your credit report.
Why do I need a letter of explanation for a mortgage?
Due to the large amount of money you’re borrowing for the purchase of a home, there’s a higher level of risk involved for the lender. This process helps put a lender’s mind at ease as you explain the relevant items.
The following are common reasons you may be required to provide a letter of explanation.
Late or missing payments
You may have a derogatory mark on your credit report due to one or more late payments. In this case, an underwriter may request a late payment explanation letter.
Different addresses
Accurate information is important, so the FTC requires mortgage lenders to have the correct address when providing a home loan. This may be requested if you moved and didn’t update your address or accidentally put the wrong address.
Gap in employment history
Gaps in your employment history may be concerning to an underwriter because they want to ensure you can make mortgage payments.
Inconsistent income
Much like gaps in employment, if you’re paid in commission for work or have extra income that fluctuates, they may want to know more details.
Large deposits or withdrawals
There are a variety of reasons you may have a large deposit in your bank statement history—for instance, selling a car, receiving an inheritance or something similar. They may also want to know about large withdrawals to ensure you have money available in your account for mortgage payments.
No rental history
A rental history shows that you can make a large monthly payment on time. If you were living somewhere rent-free, like with a parent, they may ask for a letter of explanation.
Tax return losses
If you’re a business owner or investor, the underwriter may want an explanation to show that you don’t expect large losses in the future.
Hard inquiries on your credit report
Regularly applying for lines of credit not only triggers a hard inquiry on your credit report, which can hurt your credit, but it may also indicate that you’re in need of funds.
Additional names on bank accounts
Underwriters may want an explanation if you have a child or parent on your bank statements to confirm that you have access to the funds in your account.
How to write a letter of explanation
Your letter of explanation may be sent via regular mail or email, and your underwriter will let you know which they prefer. When writing your letter of explanation, follow this format:
- You should start with the date, your name and full mailing address and a subject line that reads “RE: Mortgage application [loan number]”
- The body of the letter should contain details for each requested item, like dates, dollar amounts, names and account numbers. Most importantly, it should provide an explanation and clarification.
- You should end with a conclusion noting that you’re available to answer any questions, and then sign and print your name exactly as it appears on the mortgage application.
- Also include your phone number, names of co-borrower(s), if applicable, and a list of supporting documents, if needed.
Letter of explanation example + free template
The following is an example of what a letter of explanation may look like:
8/25/2022
Samantha Jones
1265 S. Robindale St.
Houston, TX 77042
RE: Mortgage application #44897
Dear Mr. Smith,
Below is a letter of explanation providing the information you have requested.
1. Gap in employment 5/2020 to 1/2021
Due to the COVID-19 pandemic, I was laid off from my job. Fortunately, my spouse and I always keep a good amount in our savings account, and I also received a significant severance package. This allowed us to pay all of our bills on time without any issues, and I also took on freelance work for extra income during this time.
You’ll find a 1099 tax form enclosed along with the other requested documents.
2. $50,000 deposit 10/2019 and $15,000 deposit 8/2020
In 2019, my grandfather passed away and left me an inheritance. Since I didn’t have to commute to work in 2020, we sold our additional vehicle. We have planned on buying our dream home for years, so we put this $65,000 in a high-yield savings account for our future down payment on a home.
3. Late credit card payment 3/2018
We had a family emergency in 2018 that required us to adjust our budget, which resulted in a late credit card payment. Within two months, I paid off the credit card in full. This was my only missed payment in the last 20 years, and now I have my credit cards set to autopay to ensure they are prioritized regardless of the situation.
I fully understand the reasons for requesting this information, and aside from that one missed payment, our payment history shows we’re very responsible with all our payments and bills. If approved, we can assure you that our mortgage will be paid on time and in full each month.
If you have any additional questions, please don’t hesitate to call.
Sincerely,
[Signature]
Samantha Jones
346-555-9785
Documents enclosed:
- 1099 tax form
- 2021 tax return
- 2019 bank statements
- 2018 credit card statements
We also included an editable letter of explanation template below that can be customized—whether you’re explaining inconsistent income, hard inquiries on your credit report or whatever else your underwriter wants you to address.
Five tips for writing a good letter of explanation
There are ways to write your letter of explanation to improve your chances of receiving a home loan. A letter of explanation is requested to assess risk, so by providing as much detail as possible, you can convey that you’re capable of taking on this loan and have corrected past mistakes.
Here are some tips when writing the body of the letter:
- Provide as much documentation as possible: Doing this can help expedite the process and limit follow-ups from the lender for additional documentation.
- Keep it to the point: Provide enough information to address any concerns, but try not to overcomplicate it with too many unnecessary details.
- Acknowledge the concerns: Show that you understand the reason for the concern.
- Explain your resolution: Explain how the specific situation was resolved or is being resolved, as well as preventative measures to ensure it doesn’t happen again.
- Proofread for politeness: It’s always good to proofread, but also read to ensure you don’t come off as defensive or rude. You may want to have someone else read the letter before you send it to make sure it sounds genuine and polite.
FAQ
The following are some of the most common questions people have about the letter of explanation process.
Does a letter of explanation help me get approved?
Yes. If you’re able to show that you’re in a good financial position and are responsible enough to pay your mortgage, it can significantly improve your chances of approval.
Should I worry if the lender asks for a letter of explanation?
Not at all—this is a normal part of the mortgage approval process. It may be helpful to put yourself in a lender’s shoes. If you were asked to lend a large amount of money to someone, you would probably want to know specific details and gain clarity about their financial history before giving them money.
What documentation do I need?
Provide all of the documentation that’s requested, as well as any other documentation that may be helpful.
In the example, you’ll notice the mention of an attached 1099 form. This may not have been requested, but it would prove additional income from freelance work, which supports your written explanation.
Here are some documents you may need for your letter:
- Tax returns
- Bank statements
- Copies of bills
- Termination letters (for gaps in employment)
- Divorce papers
- Unemployment benefit documents
What to do if my letter of explanation is rejected
If your letter is rejected, the lender may just want you to provide additional information. But if you still aren’t approved, then your loan most likely won’t go through. Consider looking into another lender that may be willing to work with you.
Repair your credit before writing a letter of explanation
If you don’t have the best credit history, it can be difficult to get approved for a home loan—but it’s still possible. As you’ve learned, it’s helpful to provide an underwriter with information about how your situation has improved. One of the best ways to do this is to actively work on your credit and address any derogatory marks on your report before providing the letter of explanation.
When cleaning up your credit report, it’s advantageous to seek help, and Lexington Law Firm is here to provide just that. We have a team of legal professionals who work to assist people with repairing their credit so they can improve their financial health. It’s possible you have errors on your credit report that are hurting your credit, and we can help you challenge those errors.
To learn more about how Lexington Law Firm can help you prepare your finances to apply for a home loan, contact us today.
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