Letter Of Explanation For A Mortgage
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:
- A job change, particularly in the timeframe leading up to closing
- Issues from your past that appear on your credit report
- A new credit card opening or a high credit card balance
- A large transaction (withdrawal or deposit) in your bank account
- An unsteady source of income – if you are self-employed or an independent contractor, the lender may want a better idea of your earnings
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:
- The lender’s name and address
- Your name and your application number
- The date you’re submitting the letter and expected closing date (if you know it)
- A short statement that helps an underwriter fully understand your situation in regards to the reason for concern
- Your current mailing address and phone number
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:
Date
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.
Regards,
Your name
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…
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