April 15th, 2021 9:51 PM by Jackie A. Graves
When you apply for a mortgage, you’ll need to hand over a skyscraper’s worth of documentation: your bank statements, tax returns, pay stubs, details on your debt and more. Depending on your financial situation, your lender could also ask for a letter of explanation. Here’s what that means.
What is a letter of explanation?
Mortgage lenders ask you to write a letter of explanation in order to better understand your finances when determining whether to approve you for a loan. While your lender’s underwriting department reviews factors such as your credit score and income, those figures might not paint a complete picture of you as a borrower. A letter of explanation helps fill in that picture, offering lenders a deeper understanding of your ability to repay a mortgage.
Why do you need a letter of explanation for a mortgage?
When lenders review your application for a loan, their goal is to feel confident you’ll be able to make your monthly mortgage payments. Imagine if you were loaning someone hundreds of thousands of dollars — you’d probably ask for concrete evidence that you’d eventually get that cash back, too.
If your lender asks you to submit a letter of explanation, the request is likely linked to a specific piece of information in your application that raised a red flag. A letter of explanation is simply a way to help resolve that red flag, which might include:
It might be wise to proactively submit a letter of explanation, especially if you’re aware of a potential red flag. Put yourself in the shoes of someone reviewing your application: Is there anything that might make you scratch your head?
Let’s say you took eight months off work last year to help care for an elderly parent. To the lender reviewing your bank statements, you were unemployed. With a letter of explanation, you can help your lender understand that the decision to temporarily stop working was voluntary. This might alleviate the lender’s concerns about another period of unemployment in the near future.
How to write a letter of explanation
If you need to submit a letter of explanation, be sure to include all the key details of a traditional business letter:
Letter of explanation template
While the format of your letter depends on your circumstances, you can use this letter of explanation template as a example guide:
Lender name Lender address Lender city, state and ZIP Code Lender phone number
RE: Your Name and Application Number
Dear Loan Specialist:
I am writing to explain the deposit in my [bank name] checking account of $7,500 on January 3. This deposit was a gift from my father to help cover part of the down payment and closing costs for my home purchase. I am attaching another letter from my father, which states that this is a gift and that he does not expect this money to be paid back.
I am available to answer any additional questions and look forward to our expected closing date of April 30.
Your mailing address Your city, state and ZIP Code Your phone number
If you’ve submitted an application with a co-signer, you’ll need to include the co-signer’s name on the letter, as well.
It’s important to note that you can make a letter of explanation more compelling with additional documentation. In the example above, the borrower included a gift letter from their father that supports the claim that the money will not need to be repaid.
Whatever your reason for writing a letter of explanation, consider if there are other pieces of documentation that can back up your claim, and if you have them, submit them.
Tips for writing a letter of explanation
If you need to write a letter of explanation, there’s no need to panic. Follow these three steps to put together strong support for your application:
1. Be honest
The adage of “the truth shall set you free” can be adjusted to “the truth shall help you get approved.” If your lender asks you for an explanation, it’s crucial to share the facts.
“When mortgage applicants find themselves in situations that they feel could negatively impact a lending decision, the best advice is simply to be honest,” Pete Boomer, executive vice president at PNC Bank, said. “It is their best interest to fully disclose to the lender the event or events that could impact a decision to lend money.”
2. Be formal
This letter is not the casual email you send to your colleague about lunch. The recipient holds the keys to a new chapter in your life: becoming a homeowner. With that in mind, approach your letter with a heightened degree of formality. Make your past English teachers proud with pristine spelling, capitalization and business-level construction.
3. Be brief
There’s no need to write a novel. Keep the letter concise, focusing only on the details that need to be covered. Remember that lenders process loads of applications. Rather than make their jobs more challenging with a dense piece of text, focus only on the information they need to review in order to get your application one step closer to approval.
Once you’ve submitted a letter of explanation, you’ll have to wait to hear from your lender. Make sure you respond to any additional inquiries quickly. Lenders appreciate borrowers who treat the homebuying process with the importance it deserves. As you’re waiting, make sure you’re prepared for the final piece of the puzzle: the closing. Here’s what you can expect in the closing process.
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