What Is a Letter of Explanation and When Do You Need One?

The time between applying for your mortgage loan and the loan being approved can seem like an eternity when you’re worried your application might be declined. The lender might ask you for a letter of explanation, but it shouldn’t be a cause for concern. It’s a common request, and the reason for it is usually easy to resolve.

What is a letter of explanation?

A letter of explanation is a borrower’s opportunity to address questions or concerns the lender has regarding information on the borrower’s mortgage loan application. According to Stan Reinford, a mortgage loan originator with Movement Mortgage, lenders typically request the letters for very simple reasons.

Why might a lender request a letter of explanation?

To understand why your lender might ask for a letter of explanation, it’s useful to understand how loan underwriting works. 

Underwriting is the lender’s process for evaluating your income, expenses, and credit to make sure you are able to, and are likely to, repay your loan. As part of that process, the lender does a deep dive into every aspect of your finances, including your employment history, your banking history, investment accounts, and your credit history, in addition to your credit score. The process is very thorough, so it’s not unusual for some aspect of a borrower’s finances to raise questions or need some context. 

That’s where the letter of explanation comes in. The purpose of the letter is to show that you qualify for your mortgage loan.

Common scenarios requiring a letter of explanation

Reinford says lenders request letters of explanation for many different reasons, such as:

• The address on the mortgage application doesn’t match the address on the credit report, drivers license, pay stub, bank account, or other document
• Bank statements show overdrafts
• Bank statements show an “unsourced” deposit that doesn’t come from payroll or a transfer from another, documented account, which could raise concerns that the borrower received loan money without reporting it as such
• Gaps in employment
• Credit issues such as collections, charge-offs, or bankruptcy
• Recently opened credit accounts
• Relocation to a new area that will extend the borrower’s work commute

The lender might ask for another type of explanation letter, called a “full use of funds” letter, if the borrower has a joint bank account with someone who is not listed on the mortgage application. In this case, “The person(s) would be required to write a letter that states they have full use and access to the monies for the purchase,” Reinford says.

How to write an effective letter of explanation

When it comes to writing a letter of explanation, less is more, Reinford says. If the letter is too long or contains more details than the lender asks for, it could raise more questions.

“Depending on the circumstance, the lender may ask for supporting documentation,” Reinford says. But if not, it’s best not to volunteer it unless your loan officer advises you to. 

Tips for drafting a clear and concise letter

Your letter of explanation should be short and to the point, according to Reinford. If the lender asks you for it because of a credit problem, it might give you its own list of derogatory items and ask you to use that form to write your explanation. Otherwise, Citizens Bank recommends treating the letter like you would any other business correspondence. 

Here are some tips to help you write a clear, concise letter: 

• Provide your name and contact information as they appear on your mortgage application, and the name and contact information for anyone else listed on the mortgage application. Also include your lender’s name and contact information, your mortgage application number, and the date.
• In the body of the letter, begin by introducing yourself and stating the reason for your letter. 
• Answer the lender’s request point by point, as specifically, and with as much detail, as possible. Be precise with dates and dollar amounts. 
• Acknowledge the lender’s concern, and and if necessary, explain how you’ve resolved (or are in the process of resolving) the issue to prevent a future occurrence. 
• If you need to supply supporting documentation, reference it in a way that makes it easy for the lender to find. A reference to a particular bank statement for example, should include the bank name, the account name and number, and the statement date.
• Keep a copy of your letter and supporting documents for your records.