What is a Letter of Explanation?
Underwriters are responsible for looking very carefully at all your financial information before they give you a mortgage. That means they need to see all the financial information they possibly can. They may ask for tax returns and pay stubs to find out more.
Another document they like to look for is a letter of explanation. This is something that’s used to clarify different charges to potential problems you have. For example, insufficient funds charges, changes in income and summary of rental history are just a few of the things that your underwriter might question. In fact, they can question anything they want.
Anything that causes them to question your application could require this type of letter. On top of that, you might need to give them, even more, paperwork and information. You may have to verify the things you say in your letter.
Let’s say that you just received a large gift of money from someone. You put the money in your account and it shows up on your bank statement. Your underwriter will want to look at where the money came from. They also want to know what it’s for. A letter of explanation will act as a legal statement for their records.
Why Do Lenders Ask For a Letter of Explanation?
So, why is it that underwriters even care about a letter of explanation? Because they have specific requirements that they have to follow too. The Federal Housing Administration, Freddie Mac and Fannie Mae put restrictions on what they can do.
In fact, they are all either direct government or government-sponsored organizations and they have guidelines that lenders have to follow.
When they go through the process of underwriting, lenders are looking for your ability to pay. If they can prove that you’re likely to pay they’re probably going to approve your loan. A letter will allow them to doublecheck and to verify all of the information. It lets them be totally sure they have a complete and accurate picture. That means you should really do what you can to provide the letter quickly. It’s going to let your underwriter provide you with a mortgage even faster.
Situations When a Letter of explanation is Required
Anything that seems strange or unorthodox will likely be asked for verification by a lender. Some of these things might be:
- Problems with the Credit Report – If you have late payments, missed payments, foreclosures, delinquencies and more you could be asked for a letter. That’s because a history of bad marks makes you look like a risk and lenders don’t want that. They want to make sure you’ll be able to make your payments.
- Income Changes – Losing a job could mean a gap in your income or it could mean a change in income. Once again, lenders want to make sure you can afford your mortgage. A letter could clear up any concerns.
- Large Withdrawals or Deposits – If the underwriter can find a reason for these they may not request a letter. If there doesn’t seem to be a reason they may need an explanation to account for them.
- Address Discrepancies – Your credit report is going to show your address and an underwriter is going to take a look at that. If there’s a problem they may request that you clear up address problems.
- Bank Fees – If you’ve had a history of overdrafts with your bank you may have to clear this up. After all, they want to make sure you’re not going to miss their payments.
- Job Changes – If you’ve left a job recently, been unemployed or anything else you’ll need to talk about why this happened. This is especially important if you missed some financial obligations as a result.
What if I Refuse to Write a Letter?
It is within your rights to refuse to write a letter. Unfortunately, it is also within the rights of your underwriter to refuse your loan. It is possible that writing the letter would cause your loan to be denied as well, but that happens very rarely.
By writing a letter your underwriter can figure out what’s going on with your finances and that’s going to make it more likely that you get approved. The letter will generally take care of any problems and you’ll be able to move on.
How to Write Your Letter
This is actually considered a supplemental letter and goes alongside your other mortgage information.
On top of this, it’s a short letter, something that’s only a few sentences in length. That means you don’t need to get too concerned about it and you shouldn’t say more than you have to.
You’re not going to have a right or a wrong answer. Rather, you should just say what happened. Don’t lie or make things up. Just clarify the situation in a thorough and accurate manner. If you have proof to back up your statement include that as well.
Make sure the letter is formatted in a professional way with your name, date and contact information. Make sure you address it to whomever it is supposed to be and include the resolution of whatever is being questioned. Also, state when it was resolved.
You should always make sure to sign and date your letter of explanation.
Tips For Creating a Quality Letter Of Explanation
- Relax – Don’t worry too much about a letter request. All you need to do is look for what they want to verify and then provide an answer. Keep your answer simple and to the point and wait to see if it’s enough. Don’t assume that you’re not going to get a loan because an explanation was requested.
- Honesty is Best – Keep your letter to the facts. Don’t stretch the truth or exaggerate any of the information and definitely don’t lie. Give the facts and whatever your understanding was at the time. Also, include the roles of anyone else involved and why you didn’t make timely payments. Make sure that you write the letter personally as well. Don’t request that someone else, even a loan officer, write it for you.
- Answer Quickly – It’s going to look best if you answer right away. You’re going to make a better impression and you’ll get things finished faster. If you can, respond in a maximum of 7 days after getting a request.
- Own Up to Mistakes – The underwriter already knows that you made a mistake, so own up to it. Admit the fault that you have in the situation, state the facts and move on. Now, if you were innocent or something happened to victimize you be open about it. State the facts for that as well and make sure to explain what you did and who it was reported to. Don’t try to garner sympathy with an impassioned claim.
- Skip Blaming the Creditors – It doesn’t look good for you to blame a creditor when you’re looking for a creditor to grant you money. It’s the same as bashing a former employer at a job interview.
- Provide Evidence – If you have anything that backs up what you’re saying make sure you include it. This includes things like policies, receipts, contracts and police reports. Make sure you keep the originals and send copies.