Letters of Explanation: What Borrowers Need to Know

You’ve been pre-approved for your loan, but sometimes as a lender goes deeper into your profile, they discover information that is unclear to them and clarifications are needed for your loan to be underwritten. You may be asked for a “letter of explanation” and are not sure what that means.

But don’t panic. Typically a letter of explanation is required when there is conflicting, incomplete, or unclear information in an application. In this post, we share some situations that require this common type of documentation.

Mind the Gaps

For example, a lender has to review address history. If a lender sees one show up on your credit that did not get shared in your application, they may ask if you have an ownership interest in that property since they have to identify any potential gap.

Got a gift from mom? You may have to provide a letter about, say, a large deposit in your account, in addition to providing the backup documentation to verify where the funds came from. This is required for not only down payment requirement reasons, but from an anti-money laundering regulatory perspective. Gaps in employment history also require explanation. Another example is if there is an error on your credit report or another issue that requires addressing. You could have to explain that the reason for your late payments was a layoff or medical issue. Or if it appears that you applied for a new credit card or car loan, you may have to advise if the credit line was in fact opened.

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Where do I Begin?

The letter can take on various forms. You can first have a conversation with your loan officer and the mortgage company you are working with may help you draft and send you a letter for your signature. The key point is to be detailed in what happened but in the most concise way possible, and to provide any backup documentation you can to support the explanation.

At Neat Capital, we actually have credit letters populate under certain circumstances within our digital application, and allow you to e-sign them so your mortgage is processed as soon as possible.

I Don’t Want the Hassle

To avoid having to write a letter of explanation, you should first fill out as complete of an application as possible. Be aware of the types of things that could cause someone reviewing your financial life in detail to have questions, so take the time to be thorough. For example, if you have a prior bankruptcy, short sale, gap in employment, large deposit, recent applications to other credit lines like a car loan or furniture loan, make sure that information is included. Then review your application for completeness or ask additional questions if you’re not sure. And you can always ask your loan officer for help before you complete an application.

Will my Loan Fail if I Mess Up?

Typically, letters of explanation are not rejected outright, however additional information or clarification may be requested in a second version if the first letter failed to provide sufficient information. If the explanation happens to be something against guidelines or the law, that could potentially torpedo the deal. For example, if you work for a cannabis-related company, which is discovered subsequently, many lenders may reject the loan. There are niche players, however, that can be helpful within that space.

But in the end, it’s better to be transparent and ensure you’re getting the right loan for you and not have a loan blow up in the eleventh hour, and work with the best possible lender for your unique situation.