Your lender might ask you for a letter of explanation (sometimes called an LOE) 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 they can help you get a loan more easily.
Let’s delve a bit deeper into what letters of explanation are and some reasons you might benefit from writing an LOE. We’ll also provide a letter of explanation sample template you can use to draft your own letter if or when the time comes to write one.
First, it’s important to fully understand the mortgage underwriting process. During this stage of securing a mortgage, the lender decides whether you qualify for a loan by reviewing the financial information you submitted with your application.
Mortgage companies use finance professionals called underwriters to oversee underwriting. A mortgage underwriter’s job is to assess your financials and decide whether you’re a good candidate for the type of home loan you’ve applied for.
The information available to the underwriter doesn’t always paint a full picture of your finances. An underwriter may ask you for a letter of explanation if they have questions about something they see.
A letter of explanation is a brief document you can use to explain something, like a previous bankruptcy, in your financial or employment history that might give an underwriter pause about your ability to repay a loan.
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. Such activity could include large deposits or withdrawals from your checking or other bank accounts. A drop in your credit score due to credit inquiries, overdrafts, late payments or some combination of these activities could also send up a red flag.
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 just need clarification or some additional information about your financial situation, maybe in the form of a bank statement or a billing statement. Explanation letters can also help your mortgage lender determine how much house you can reasonably afford, which can streamline your search and help you get into a new home sooner.
Secondary authorities that own or back the loan may also require a letter of explanation.
Many of their guidelines dictate that the lender must get a mortgage letter of explanation for certain items on a borrower’s report. Secondary authorities that impose such underwriting standards include:
Lenders offering jumbo loans may have even more qualification standards.
Next, we’ll review examples of reasons you may be required to provide a letter of explanation.
Lenders need to know you have no trouble managing your finances. Negative items on your credit report can alarm 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:
Letters of explanation addressing these issues should include:
It should also include an explanation of why you don’t foresee this problem happening again.
Rent or mortgage payment history shows a lender whether you’re capable of paying your housing costs on time. If you’ve been living for free somewhere, like your parents’ home, you’ll need to prove that to your lender with a letter of explanation from the homeowner, 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.
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 stating the farm isn’t on the property you’re buying. The LOE must also include the address of the farm that’s tied to the income or loss. This is necessary since the underwriter can’t get this information from your tax documents.
When determining the value of the home, another structure on the property can’t be the primary reason for that value. It’s worth noting here that some lenders, including Rocket Mortgage®, don’t finance farms.
You’ll need a steady and reliable income to keep up with the payments on a home loan, so long gaps in unemployment may make you seem like a risky borrower. For VA and jumbo loans, your lender may require a letter of explanation for gaps in unemployment within the last 2 years. A letter may only be required when gaps in employment are greater than 30 or 60 days, depending on the type of loan.
You’ll need to explain what caused any gaps, which can come about for various seasons that include:
If you still met your financial obligations during this time, note that information, too.
Remember that an explanation letter is ultimately a tool that helps demonstrate you’re a qualified buyer. By addressing any worries about your financial history, you can increase your chances of getting approved for a mortgage and start hunting for your new home sooner.