Buying a house can be a fraught process, but when the market is hot, the days between offer and closing can feel endless, especially if the mortgage underwriter asks you to write a letter of explanation.
But there’s no need to panic—or assume that your mortgage application will fail. The lender is simply seeking clarification about any red flags in your financial documents or credit history.
What’s a Letter of Explanation?
Because a mortgage is a large loan, lenders need to know that the borrower is capable of shouldering the mortgage.
Lenders also know that life can’t be boiled down to a spreadsheet, and that it’s not unusual for a mortgage application to include things like a late credit payment or a period of job loss.
To do due diligence, the mortgage underwriter will ask you to explain the situation in a brief letter, which will be added to your mortgage application. Additional documentation and paperwork may be required.
Why Do I Need to Provide a Letter of Explanation?
Here are common issues that could trigger a request for a letter of explanation:
• Questions about your income if you don’t have W-2s or are self-employed
• Negative items on your credit report
• Employment gaps
• Your living situation if you don’t pay any rent or mortgage
• A property income or loss you claim
• Credit lines opened after you’ve put in your mortgage application
• Large deposits to, and sometimes withdrawals from, your bank account
Must I Explain a Large Deposit?
If there’s a big or unexplained deposit to your bank account, your lender may want to know where the money came from—and whether that money needs to be paid back.
A lender may also question any uneven income streams, or if deposits don’t line up with your W-2s or your tax returns.
If you received cash from, say, a parent to help with a down payment or closing costs, you may also need a gift letter signed by the giver and recipient that the money was a gift, not a loan. Your lender may have a template for a gift letter.
Your lender may be more likely to scrutinize any large deposits or withdrawals within the last 60 days.
Letter of Explanation Template
A letter of explanation is not an autobiography or an admission that you did anything wrong. It’s simply a statement of the reason for any discrepancy or issue, along with any documentation, to back up your current financial picture.
You can keep a letter of explanation brief. It should include:
• Your name and address
• Your lender’s name and address
• A subject line that includes your application number and name
• A brief paragraph explaining the situation
• A polite closing
• Your signed full name
It might look like this:
RE: John Doe’s Loan Application, No. 6666666
Dear Sir or Madam:
I’m writing this letter to explain (the matter).
Please let me know if you need further clarification. Thank you.
John Doe (signed)
Enc.: (Relevant documentation).
The explanation paragraph can be both detailed and vague. Your lender will need to know dollar amounts, any relevant account numbers, and any resolution. Explain what caused a situation (for example, a job loss led to missing a credit card payment), but you don’t necessarily want to get stuck in the weeds about the “why.” Instead, it’s important to focus on how you rebuilt from that moment, supported by documentation.
Using the example, you could include your offer of employment when you got a new job, along with account statements showing proof of payment since then.
The tone of the letter should be polite and factual. Remember: Your goal is not to pull on the lender’s heartstrings; it’s to reassure them that your application is solid and you would responsibly pay back your mortgage on time.
If you’re describing a layoff, the underwriter doesn’t need to hear about your toxic boss or the confusing company culture. They just need to hear the barebones facts: Because of restructuring, your position was eliminated, which caused you to get behind on some of your bills.
Getting Your Mortgage Application in Shape
Knowing what documents you need and what a mortgage lender will look at can help get your application in strong shape before you file it. Your lender will scrutinize your credit history, and late payment, especially one within the last 12 months, may raise a red flag. But there are ways to proactively tackle any issues on your credit reports.
• Check your credit reports . Knowing what your mortgage lender may see can help you assess where any weak points may be, and what information they may ask for.
• Call the creditor if you have a recent late payment. Creditors know that accidents happen and bills may be misplaced. If your account is otherwise in good standing, it’s possible that a creditor may erase the late payment.
• Focus on additional aspects of your credit. Making sure to pay bills on time and keeping your credit utilization below 30% can help build credit.
• Think twice about opening accounts. Before and after applying for a mortgage, it can be a good idea to be mindful of opening new lines of credit or charging an extensive amount on current cards. Sometimes people who get preapproved and successfully make an offer on a house may get excited and begin buying furniture. But suddenly taking on more debt on cards can raise a red flag to lenders, which may result in being asked to write a letter of explanation.
Understanding how a lender will see your mortgage application can give you confidence and may help you head off any potential problems.
Recommended: Preapproved vs. Prequalified: What’s the Difference?
A letter of explanation is just that when a mortgage lender needs clarity about a red flag or discrepancy that arises after your application. Knowing what to expect, having any documentation in place, and answering the question can all be helpful in getting your home loan approved.
Are you in the market for a mortgage? If so, look into SoFi’s fixed-rate mortgage loans with terms of 10, 15, 20, or 30 years. You may be able to put as little as 5% down.
Photo credit: iStock/scyther5
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