What is a letter of explanation?A letter of explanation is a short document that allows you to clarify your financial situation and address any concerns an underwriter may have while reviewing your mortgage application.Underwriters examine your financial history and determine if you qualify for the home loan you’re applying for. Since loan applications don’t include space for explanations, an underwriter may request that you submit a letter of explanation as evidence that you meet the funding criteria.
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Why do you need a letter of explanation?There are several reasons why an underwriter or mortgage lender may request a letter of explanation. Most pertain to gaps in employment, rental history or on-time payments. Here are some of the most common reasons you may need to write a letter of explanation.
1. You have a poor credit historyYour credit history helps lenders know how you’ve handled debt in the past. The following red flags can potentially indicate poor debt management and may require a letter of explanation:
- Late payments
2. You don’t have rental historyIdeally, lenders want to see that you have a consistent rental history for the last 12 months. This reassures them that you will be able to handle regular mortgage payments. If you have a gap in your rental history, explain the cause. Caring for a family member or recovering from an accident are possible explanations for a rental hiatus.
3. You have employment gapsSimilar to your rental history, lenders prefer to see consistent employment in the year prior to your loan application. This shows the lender that you have the income to make regular mortgage payments.It’s possible for a lender to be flexible when they know more about the circumstances that led to an employment gap. Being laid off or raising children are possible explanations for the lack of recent work experience.
4. You report different addressesIf the address on your driver’s license does not match the address on your loan application or credit report, a lender may ask you to explain the discrepancy.
5. Your income is inconsistentUnderwriters will carefully review your income. If it fluctuates often, they may request an explanation letter. If you are self-employed, your accountant may also have to write a letter of explanation to verify how you generate your income.
6. You work remotelyIf your remote career is tied to an address in a city or state that is different from where you are buying a home, a lender may request that your company provide a letter of explanation verifying that your career (and income) will not be affected by your move.
7. You have substantial losses on your tax returnIf you are a self-employed business owner or independent contractor, it’s normal to file losses on your first few tax returns. A lender may request a letter of explanation to ensure that these losses will not be consistent and will not affect your ability to make regular mortgage payments.
8. You cosigned a loanIn the event that you cosigned a loan, a lender will want an explanation letter ensuring that you are not the one making the payments. This can apply to student loans, auto loans and mortgages.
9. You opened a new credit accountIf you open a new credit account while applying for a mortgage loan, a lender may suspect that the debt could affect your ability to repay your loan. Remember that the underwriter will also review your finances during closing, so hold off on opening new lines of credit until the sale is complete, if possible.
10. Your family members are on your bank statementsIf multiple people appear on your bank statements, like parents or children, you will need to write a letter explaining that you’re in control of the funds being used to pay for your new home. Anyone who helps you with the down payment of the home will also be responsible for writing a gift letter of explanation.
11. Your accounts are under fraud alertA lender will want to know that you’re aware of any suspicious activity on your credit report. If your accounts are under fraud alert or your credit is frozen, prepare a letter of explanation that outlines how you will regain control of your finances.
How to write a letter of explanationBefore you write a letter of explanation for mortgage financing, you’ll need to gather the following records:
- Your full legal name
- Your spouse's full legal name (if applying together)
- Your current mailing address
- The address of the lender
- Your phone number
- Marriage license if applicable
- Bills of sale (for large assets like a car)
- Title transfers
- Address your letter: Write the date and lender’s address at the top of the explanation letter, then address the lender or lending institution.
- State your financial situation: Be upfront about your financial issues. Your application already indicates something suspicious to your lender, so there’s no need to hide the truth. Quickly state the fact of the matter and proceed.
- Briefly explain the circumstance: Keep your letter as concise as possible. After you state the problem, provide a short explanation of the circumstances around your issue.
- Share proof that you’re prepared: After you explain your financial situation, provide the lender with evidence that you are now capable of buying a house.
- Proofread and close your letter: Check your letter of explanation for any spelling or grammatical errors. Ensure that the tone of your letter is professional and courteous, then close the letter with your full name and current address.
Letter of explanation templateAn explanation letter request is no cause for panic. Here is a letter of explanation example to help point you in the right direction:September 20, 2023Faux Lenders 333 Rent Free Ridge Dallas, TX 75088Dear Faux Lenders,I’m writing to you to explain the late payments from 04/03/2022-05/04/2022 on my Visa credit card, account #7654321.On March 30, 2022, my spouse had a serious accident that resulted in large medical bills. I was working on a payment plan with the hospital when I missed those credit card payments on my account. As of May 5, 2022, my credit history shows that I have since made regular payments to my credit card company and the hospital. I have attached a copy of my credit card statements from May 5, 2022, to today as evidence of my improved credit score and ability to make timely payments.Sincerely,John Doe 777 Fake Lane Dallas, TX 75088Writing a letter of explanation can get you one step closer to financing the second home of your dreams. For best results, remember to keep your explanation letter brief, honest and respectful.While you're exploring options for financing a second home, consider the possibilities of fractional ownership. This type of ownership can help you afford more home for less and reduce the amount of mortgage you are responsible for paying. And a fully managed co-ownership model like Pacaso, you leave behind many of the costs of owning a second home like maintenance, upkeep and furnishings. Plus, Pacaso offers flexible financing options.Refer to our free template if you need help preparing an explanation letter for your next real estate purchase.
Letter of explanation FAQ
What is a letter of explanation for a mortgage lender?
A letter of explanation clarifies negative marks on your credit report and assures an underwriter or lender that you are capable of paying off a mortgage.
How long should a letter of explanation be?
A letter of explanation should be as brief as possible, consisting of three paragraphs that span no more than three-quarters of a page.
What is a letter of explanation address verification?
You’ll need to send a letter of explanation address verification to your lender if your current physical address does not match the address on your mortgage application or credit report.