What Are Explanation Letter?

You have probably sent an explanation letter at least once in your life. As students, our teachers or professors would ask us to explain our lack of attendance in class or in school activities. We had to furnish them with a letter containing our reason for not being able to attend on that particular day. If we were sick, we had to attach a medical certificate with the letter. Now as working citizens and a regular employee of a company, whenever we had accumulated x numbers of successive lates in a week we are sent a notice to explain by the head HR that we need to come up with a reply within the day. All mentioned are common instances where explanation letters are used. However, explanation letters are not confined to merely these instances, it is also predominantly furnished to banks and bank underwriters. 

If you are trying to get a loan for a house, banks will require you to fill out tons of paperwork. Ideally, the paperwork contains all the information the lender-bank needs to know to approve the application. However, in some cases that is not true. If the bank finds some discrepancies in the form you have filled out and their investigation, they might ask for an explanation letter. It might sound daunting, but it is not a big deal. Often, they ask simple questions to help clear out facts that they are unsure of. The primary purpose of explanation letters is to help the bank assess whether you have the ability or financial capability to pay the loan back. Once they are satisfied with your documents and application form, chances are they will approve your loan or mortgage application. 

Instances a Bank Underwriter Will Ask For An Explanation Letter

The main reason why a mortgage lender or loan officer would ask you for an explanation letter is for him to thoroughly understand your financial standing. If he sees anything out of the ordinary in your credit history that would cause suspicion or those that can be considered as red flags, he may request an explanation coming from you to explain your side. Some common instances a mortgage lender or loan officer will ask for an explanation letter are as follows: a history in bankruptcy for a failed business undertaking, foreclosure of a previous mortgage, delinquency in paying credit, job change, erratic income, change in name, having multiple social security numbers, loan delinquency, pending civil or criminal case in court, constant change in address, downsizing to a condo or apartment, job gaps or history of non-employment, large deposits or withdrawals in one of your bank accounts, existing loans or credit, and other miscellaneous circumstances of unexplained financial irregularity.
You can explain these occurrences to the loan officer through the explanation letter. If he finds your reply satisfactory, then there’s a higher chance of your loan or mortgage application getting approved. Hence, be mindful of how you write the letter and its content. It could either make or break your loan or mortgage application.

How To Write a Satisfactory Explanation Letter

Millions of Americans dream of buying their own homes. When they apply for a mortgage application, their major concern is “will the bank say yes or turn us down?” Shockingly, a huge number of loan applications don’t make it. As reported by The Washington Post, about 1 of 10 mortgage applications are turned down. According to a 2017 survey conducted by the Federal Bureau of Consumer Financial Protection, around 10.8% of these applications are denied. To avoid this, an applicant should take caution in the application process. Especially when asked to provide an explanation letter. To help you, below are some tips you can follow when writing an explanation letter to your lender or bank underwriter.

Step 1: Understand the question

Bank underwriters usually request letters of explanation to clarify the reasons behind a person’s financial history that could potentially affect his ability to pay the loan. Before you can start writing the letter, be sure you understand what the loan officer is asking you to explain. It is best to ask questions and specific instructions from the requesting party to be able to come up with a responsive reply.

Step 2: Provide a direct and clear answer

Explanation Letters to a mortgage underwriter are not letters per se. A common misconception when writing letters of explanation is that it is long. But, you only need to provide just one or two liner sentences. The reader will greatly appreciate a direct, concise, and clear reply. So keep it short and direct to the point. You do not need to explain profusely, just enough to clearly answer the lender’s inquiry.

Step 3: Attach documentation

Most loan officers will ask you to secure supporting documents with the letter. Even if you are not asked for such documents, consider including it since it would greatly benefit you. When you do have to include these to your letter, make sure you provide certified copies or originals. If you send the original, keep a copy for yourself for future reference.

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FAQs

Is my creditor allowed to reject my explanation letter?

It is common for creditors to ask you for an explanation letter explaining a bad debt history, change in job, change in residence, or about any else that could potentially affect your financial credibility in paying an ongoing credit line with them. Basically, anything that affects your ability to pay, your creditor has a right to look into it and investigate. Initially, he will ask for an explanation letter from you and hear your side of the story before he can start his own investigation. However, if your explanation letter is unsatisfactory and seems not believable, your creditor has the right to reject it and may cause the termination of your lender-borrower relationship. One of the major causes why creditors reject an explanation letter is the lack of documentation that backs up the claims made in the letter. When writing one, be sure to attach the proper evidence that can back your explanation.

What happens if my potential lender rejects my explanation letter?

If a potential lender rejects your explanation letter, it may also mean he is rejecting your loan application. If this does happen, the first thing you should do is find out why the lender disapproves so. It may be because the letter was written unsatisfactorily. You can ask a potential lender how to refine it up to his standards. Most often, a lender (especially for underwriters working for banks) will work with you and help you in your loan application process to make the approval easier and faster. Common advice they give to loan applicants when writing their explanation letters is to attach supporting documents to the letter. However, if it gets rejected again, you might want to try with another lender and work with improving your credit.

Why do lenders and bank underwriters ask for an explanation letter?

Mostly, lenders and mortgage underwriters ask an applicant for an explanation letter to protect themselves as creditors. Before they can grant your loan application, they need to make sure that you have the means to pay them back for what you owe them. Asking the letter is a way for them to cover their bases, to make sure that they have exhausted efforts in doing a background check on you, especially your credit history. With this in mind, make sure when you are asked for an explanation letter, you should send one quickly and provide accurate information so your credit application will get approved. If you choose to not provide the letter, or send it late, you could forfeit your application or your loan could get denied.

What documents should I attach in my explanation letter addressed to a mortgage lender?

In the event, a mortgage underwriter assigned to you will ask you to provide an explanation letter, it is best to attach supporting documents. Basically, any document or records that can corroborate the claims made in the letter. However, if you are unsure what to include as an attachment, ask for clarification or advice from the underwriter tasked to manage your loan application. He might you specific instructions. The documents that should be attached in an explanation letter vary from a case to case basis. For example, a potential lender found out an erratic change in your income flow. You explain the change is due to you embarking on a business venture. You can attach in the letter a copy of your business permit to back up your claim that you have just opened your new business.

How do I avoid having to write an explanation letter?

One of the things you can do to avoid having to write an explanation letter is to fill out the loan application form as completely as possible. Make sure all entries you write do not raise suspicion on your ability to pay the loan back. Be cautious in answering questions that could cause a potential lender to review your financial background. For example, you have a history of bankruptcy for a failed business undertaking. Be upfront about this fact, and explain outright and thoroughly the circumstances leading to the bankruptcy. If you are having difficulties filling out the loan application form, ask for assistance. A clean, complete, and convincing loan application form will have a higher likelihood of getting your loan approved.

If something in your loan or mortgage application form raíses a concern or considered as a red flag to the mortgage underwriter, you may have to provide an explanation letter to clarify the situation. Most of the time, you might also provide the supporting documents along with the letter. If you are asked for one, do not panic or be scared. It is pretty common and a normal part of the loan or mortgage application process. To help you get started in writing one, you can download our sample templates above. All you need to do is download, fill it out, and print.