What we'll cover
What a letter of explanation is
The reasons you might provide one
How to draft a well-written letter
When you're looking into buying a home or refinancing your existing home, your lender might ask you to provide a letter of explanation. Don't get too anxious if you need to write one — it's your chance to fill in any information gaps.
What’s a letter of explanation?
When you apply for a loan, an underwriter will consider how risky it might be for the lender to approve your application. Underwriters are professionals who review loan applications to determine whether they are eligible to receive an initial mortgage loan, jumbo loan or refinance. If an underwriter is uncertain about information in your application, they can request a letter of explanation. They may ask you to provide context for certain details included in your loan application.
Read more: Is now the right time to refinance your mortgage?
Why you might need a letter of explanation
It might seem stressful or inconvenient to write a letter of explanation, but think of it this way: It's an opportunity to share additional details about your loan application to help move it along. You can even be proactive and send a letter of explanation along with your initial application if you know there are details you'd like to clarify. Some situations that may require explanation are:
Credit report challenges
Lenders need to make sure you'll make your mortgage payments promptly. When a creditor reports you have missed payments or defaulted on a loan, your credit report can reflect that. These details can result in a red flag for mortgage lenders.
Your letter should address any credit issues, including details like the dates they occurred. You should also explain how your circumstances have changed and why these issues won't happen again moving forward.
Large gaps in your employment history
When you can't prove that you had a job for a particular length of time, you may need to explain gaps in employment. You may be able to point to an inability to find a job, maternity leave, going back to school or loss of a business. It's a good idea to explain how you supported yourself without regular employment during this time.
No rental history
If you don't have evidence of rental history, you may need to explain how you lived with a family member or a friend who didn't charge rent. It can help to demonstrate how you plan to make your future mortgage payments.
Large bank transactions
Lenders like to see that your bank deposits align with your job's paydays and other money that you regularly bring in. They look for evidence of a stable, predictable source of income versus large deposits of gift money or loans. Similarly, a lender may believe that you're struggling financially if they notice large withdrawals. If these major transactions are unavoidable leading up to your home loan, provide some background as to why they happened.
How to write an effective letter of explanation
Keep your letter honest, professional and to the point. If you're aware of details that need clarification, use those as opportunities to provide specifics on your situation. Try to avoid making excuses or being defensive about your finances — honesty is the best policy here. An accurate, complete account of any unusual parts of your application can go a long way. But do your best to steer clear of emotional language or lengthy, unrelated detours. If you have any documentation that supports your explanation, include it as part of your letter. Take a look at the following example for guidance:
Once you've written your letter, have a friend read it over for clarity, spelling and grammar. Try to send the letter as soon as possible so your mortgage application stays on track.
Why a letter of explanation matters
When a lender sees a potential red flag, they need your information so they don't expose themselves to undue risk. The real-world details of your finances can be too complex to fit into the container of a loan application, but further explaining your situation can bring you one step closer to becoming a homeowner.
