A letter of explanation gives you an opportunity to explain potential red flags in your credit history, which could help you land the home of your dreams even if you might otherwise be considered a less-than-ideal borrower.
For many of us, our home is the largest single purchase we’ll ever make—and perhaps the largest loan we’ll ever take out, too. It makes sense that lenders want to make sure you’re good for the money when they’re dishing out hundreds of thousands of dollars in cash.
That’s why you may be asked to write a letter of explanation as part of the underwriting stage of your mortgage application.
Just What Is a Letter of Explanation?
If you have questionable items on your credit report, a letter of explanation may be requested by your underwriter—the person at the mortgage company in charge of gathering and verifying your materials to make sure you’re a good candidate to apply for a home loan.
As with other types of loans and lines of credit, qualifying for a mortgage comes down, in large part, to creditworthiness: a borrower’s credit score, history of paying loans on time, maintenance of a low credit utilization ratio, and overall history of money management.
As part of the homebuying process, the underwriter will pull your credit report and look into all these details, and if they come across any red flags, they may ask you for a letter of explanation.
Situations When You Might Need a Letter of Explanation
There are a variety of situations in which you might be asked to provide a letter of explanation, and they’re not all specifically about your credit report—though many of them are. The underwriter may request a letter of explanation if:
• Your credit history shows late payments, accounts in collections, judgments, or other detracting factors
• There’s a discrepancy between the demographic information, such as your name and home address, on your credit report and the information you’ve provided in your mortgage application
• You’ve been living rent-free—in which case you’ll need a letter of explanation from the owner of the home, not one you’ve written yourself
• You’ve experienced big swings in income
• You’re applying for a mortgage solo but hold a joint bank account
• You have long gaps in your employment history
Basically, a letter of explanation might be requested any time something in your file needs … well, extra explanation.
4 Tips for an Effective Letter of Explanation
Although being asked to write a letter of explanation may sound like being assigned homework, it’s actually a great opportunity: It means you might be able to qualify for the loan you want even with an imperfect application.
Since the stakes are so high, you probably want to write the best letter of explanation possible. Here are some tips to help ensure you get an A+ on this particularly important homework assignment.
1. Keep It Simple
When you’re asked to explain yourself, it can be easy to jump into a broad-reaching narrative starting from childhood, but the best letters of recommendation tend to be short and simple: They clarify the situation being asked about and reassure the lender that the “red flag” situation won’t affect the borrower’s ability to repay the loan.
If you’re feeling stuck, you might try a mortgage letter of explanation template to help get the ball rolling. Here’s a fairly standard version:
Date
Lender
Lender’s Address
Lender’s Phone Number
Subject Line (RE: John Doe’s Mortgage Application)
Letter of explanation, naming the specific item being asked about and explaining it to the best of your abilities.
Sincerely,
Applicant’s Name
Applicant’s Address
Applicant’s Phone Number
2. Provide Clear Details
Generally speaking, you’ll want to specifically name whatever item you’re being asked about (late payments on a credit card account ending in 0101; an employment gap between 2/20/2020 and 9/07/2020; etc.).
Then explain. For instance, if you’re being asked about an employment gap, you might let the lender know that you were let go as a result of corporate downsizing and that you freelanced while searching for a new job.
If you’re being asked about late credit card payments, you might let the lender know that you were in the hospital at that time and thus unable to make your credit card payments, or whatever the case may be.
The key is to take responsibility for the issue and provide clear, pertinent details without being too wordy.
3. Be Honest
This may go without saying, but you definitely don’t want to lie in your letter of explanation. For one thing, doing so is likely to keep you from being approved for the mortgage—and for another, it can be considered mortgage fraud, a serious crime that can come with prison time and fines.
4. Acknowledge Responsibility, but Don’t Get Emotional
When writing a letter of explanation, you may be justifying negative items in your credit history that resulted from poor decisions—or just poor circumstances. Nobody’s perfect, but a lender simply wants to make sure you won’t default on your loan.
So it can be helpful to acknowledge the ways you’ve adjusted your financial habits in response to a negative item and to reassure the lender that it won’t have an impact on your ability to pay your mortgage.
For example, if you’re writing a letter of explanation to address late rent payments after a layoff, you might add that you’ve since saved up an emergency fund of three months of living expenses in order to avoid being financially blindsided in the future.
However, writing an emotional sob story won’t help. Remember: It’s a good idea to keep it simple, clear, honest and as short as possible while still covering all those bases.
The Takeaway
You may be asked to write a letter of explanation as part of your mortgage application process. The letter offers you a chance to explain any discrepancies or red flags on your credit report or other application materials.
Letters of explanation are a small part of the larger homebuying process—and SoFi is there for you every step of the way, from mortgage preapproval to move-in day.
SoFi offers home mortgage loans with competitive, fixed interest rates and terms ranging from 10 to 30 years.
Photo credit: iStock/monkeybusinessimages
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