35+ Sample Letter Of Explanation Templates

What is a Letter of Explanation?

When you are having trouble applying for a loan, a letter of explanation might help you, especially during the process of underwriting. Underwriting involves evaluating the risks a lender has to take for every loan applicant. Usually, mortgage companies let professional underwriters do the job for them. If an underwriter is not satisfied with the information a borrower provides, he may ask for a letter of explanation. A letter of explanation, from the word “explanation” itself, is a document that answers and explains the questions that are in the mind of an underwriter concerning your finances. Letters of explanation are a lender’s way of saying that they are willing to let you borrow money. According to Statista, the total mortgage debt of Americans from 1950 to 2019 increased from $0.05 trillion to $10.61 trillion. That is one of the reasons why lenders must first assess the risk before placing their money on the line.

Reasons Why You Need to Create a Letter of Explanation

The following are reasons why a borrower must provide an explanation letter to his lender:

Derogatory credit. Lenders must know if you have difficulty handling your finances. A bad credit report is a red flag that underwriters will strictly take note of. An underwriter may assume that you have trouble in settling your bills. That is why you need to make a letter of explanation that explains why you missed your payments or why you weren’t able to pay anymore.Self-employment. A self-employed person doesn’t have a fixed income every month. For that reason, it may be hard for an underwriter to distinguish between your grants and income deposits. So, it is vital to provide an explanation letter that clearly spells out your mean income as a self-employed individual.Unusual deposits. You must convince your lender that you are not going to use the money for a down payment. If you are planning to use it for that reason, it will only mean that your loan application is risky. Lenders don’t want that. Moreover, he must know why your present income doesn’t match with your large bank deposits.Large withdrawals. This is also one red flag that underwriters will keep their eye on. Sudden withdrawal of large amounts of money may be a sign that you are keeping them for a reason. One reason may be to successfully qualify for the loan. Another reason may be that you are about to risk your finances. Therefore, writing a letter of explanation will help your lender understand why you have large bank withdrawals all of a sudden.New credit accounts. Owning several credit accounts isn’t something to be proud of. It may mean that you’re making a very risky decision. A mortgage involves a large amount of money, therefore owning a new account is bad news for your lender. That is why a lender may ask why you’ve opened a new account while applying for a mortgage.Overdraft fees. You can be a big risk for lenders if you’re bad at managing your money. When an individual’s withdrawal or payment exceeds his available balance in his bank account, the bank usually covers up for the transaction in honor of their “overdraft protection service”. When that happens, the bank will ask for an overdraft fee. Having that kind of history in your bank statement signifies that you’re bad at handling your finances. So, it is good that you provide a letter of explanation if you have a lot of overdraft fees on your bank account statement.Employment issues. You need to be stable financially so you can pay a mortgage loan. A pause in your employment history may indicate that you are behind paying your bills. Therefore, provide a copy of a document that confirms your current employment status along with an explanation letter to your lender.Other existing debts. You might be having a lot of existing debts such as college or credit card loans. This can be a heavy burden for you while paying for a mortgage loan. It can even be more difficult if your existing debts are larger than your monthly income. Come to think about it, you still have monthly expenses to pay for. For that reason, you must calculate your DTI or debt-to-income ratio first before applying for a mortgage. If your DTI is greater than 50%, an underwriter might require a letter of explanation.Residential concerns. If you reside in a house for at least a year, the house can be regarded as your primary residence. There are rules that apply to both primary and secondary residences as well as investment properties. There are some loans supported by the government that are only for primary homes. Purchasing a new primary home even if you currently have one will require a letter of explanation, especially if you don’t have plans to sell your home. The letter of explanation should specify where your current home is located.

How to Write a Convincing Letter of Explanation for Mortgage

A letter of explanation depends on what reason you are writing it for. When you’re drafting your letter, keep it connected with your present situation. The following are steps in writing a persuasive letter of explanation.

Step 1: Know the Content of Your Letter

An explanation letter is just a short letter that comprises of the following information: (1) the date you write the letter, (2) the lender’s name, address, and contact information, (3) your name and loan number, (4) a paragraph explaining your current situation, (5) a conclusion that indicates you’re open to answer any additional questions, (6) your legal name and signature, (7) your co-borrowers’ legal names if there are any, and (8) your contact information and mailing address.

Step 2: Keep Your Letter Short and Straight to the Point

The purpose of making a letter of explanation is to let an underwriter understand your circumstance. So, be straightforward with your answers. Don’t open up an issue that is not related to the main issue unless it’s necessary. Remember that the goal is to persuade the underwriter of your capability to take responsibility for a loan agreement regardless of your mistakes in the past. Don’t add up to his hesitations.

Step 3: Explain the Reason for Your Past Failures

This is the most crucial part of your letter. Be careful not add up doubts in the mind of an underwriter, especially when he has seen a pattern of non-payment in the past. Explain your reasons clearly and convincingly that those past failures happened because of an unexpected event resulting in your financial hardship. Also, try to make it up by saying that you are more stable now and are more confident to pay for a mortgage.

Step 4: Be Professional and Polite in Your Approach

Even if the thought of writing an LOE bothers you, you must keep your tone formal and polite at the same time. Don’t get too irritated because the underwriter is just doing his job. An approach that is polite shows that you have respect for both the lender and the underwriter. Who knows that this might be a reason for them to approve the agreement.

Step 5: Review Your Letter

A letter that has many spelling and grammatical errors will give a bad impression. Also, you must ensure that all the information you’ve written is correct. Moreover, an incorrect name and loan number may delay your application. Therefore, proofreading your letter is essential.

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FAQs

What are the main things that a lender looks for before approving a loan?

There are four main things that a lender looks for before approving a loan: (1) Capability. Are you capable of paying your loan? The lender will ask for your employment history and will also assess your current employment status as well as your income. (2) Credit history. Are you really willing to pay your debt? The lender will keep an eye on your credit history and see whether you have remaining debts, or how frequently you borrow, or whether you delay paying your bills. (3) Capital. Is your money enough to afford the down payment and all other mortgage expenses? Do you need help from a relative? Will you still have money after paying the initial costs for mortgage? (4) Collateral. Do you have an asset that is equal to the value of your loan in case you default? The lenders must make sure that the house you are purchasing is enough to back that up.

Will I get my deposit back after my request is rejected?

The purpose of the deposit when applying for a loan is to assess your property or credit-worthiness before a lender decides to approve your application. Therefore, you will not get a refund once the process has begun. You can only get a refund before any procedure begins.

How much mortgage loan can I be entitled to?

Before purchasing a property, you must first determine your budget. There is a standard rule that says a home you can possibly afford is equal to two and a half times your yearly gross income. The maximum loan you can apply for depends on your income, remaining debts, the price of the home, the down payment amount, the loan interest, and the cost of insurance and taxes.

Will a fixed mortgage change throughout the loan process?

Your monthly payment may change or fluctuate during the loan process. However, a fixed loan rate doesn’t change throughout the loan process. Only your insurance fees or taxes may fluctuate over time. The principal amount and the interest rate will not change throughout the mortgage term.

What is an escrow account?

Escrow is a term used to describe a process where an asset or money is kept safe by another party on behalf of a lender and a borrower. An escrow account is under the control of an escrow agent who keeps the assets or funds until there are further instructions given or until the contract has been fulfilled.

A letter of explanation is a chance for you to qualify for a mortgage loan. At the same time, it also protects a lender from taking too much risk for his business. Even though it is only a short and simple document, a letter of explanation impacts your request for a loan.