Letter of explanation: Why it’s important and how to write one

Maybe you recently changed jobs, took time off work, or made a large deposit into your bank account. Then your mortgage lender asks for a letter of explanation. It might sound a little formal and even a bit stressful, but it is a common part of the mortgage process.

A letter of explanation, also known as an LOE, is a short note that helps fill in any blanks your underwriter might come across when reviewing your application. While it can feel like one more thing to check off the list, sharing a bit of context can help keep your loan moving forward without delays.

What is a letter of explanation?

A letter of explanation is a brief document you can use to explain a previous bankruptcy, a gap in your financial or employment history, or any other event that might give an underwriter pause about your ability to repay a loan.

Don’t assume your lender won’t be able to give you a loan if they need one of these letters – the opposite is often true. They just might need clarification or some additional information about your financial situation, maybe in the form of a bank statement or a billing statement. Explanation letters can help your mortgage lender determine how much house you can reasonably afford, which can streamline your search and help you get into a new home sooner.

Why do I need to provide a letter of explanation?

There are many reasons you may be asked for a letter of explanation. You may need to write a letter of explanation if you have unusual or sudden activity in your credit report or banking statements. Such activity could include large deposits or withdrawals from your checking or other bank accounts. A drop in your credit score due to credit inquiries, overdrafts, late payments or some combination of these activities also could send up a red flag.

Secondary authorities that own or back the loan also may require a letter of explanation. Many of their guidelines dictate that the lender must get a mortgage letter of explanation for certain items on a borrower’s report. Lenders offering jumbo loans may have even more qualification standards. Secondary authorities that impose such underwriting standards include:

• The Federal Housing Administration (for FHA loans)
• The Department of Veterans Affairs (for VA loans)
• Fannie Mae or Freddie Mac (for conventional loans)

You have negative items on your credit report

Lenders need to know you can manage your finances. You may need to provide a letter of explanation for any negative items on your credit report, including:

• Missed payments
• Defaulted loans
• Foreclosures
• Repossessions

Letters of explanation addressing these issues should include:

• An explanation of the negative event
• The date it happened
• The name of the creditor
• Your account number
• Your signature and date

It also should include an explanation of why you don’t foresee this problem happening again. For example, you might note that you’ve created a monthly budget, set up automatic payments, or built an emergency fund to help you avoid missed payments going forward. If the issue was tied to a job loss or medical emergency, you can mention that you’re now employed or have more stable financial footing.

You’re living rent-free

Rent or mortgage payment history shows a lender whether you’re capable of paying your housing costs on time. If you’ve been living for free somewhere, like your parents’ home, you’ll need to prove that to your lender with a letter of explanation from the homeowner, not you.

In the letter, the homeowner should state that you’re currently living in their home rent-free and indicate how long you’ve been doing so. Make sure they also sign and date the letter.

You have income or loss from a farm property

If you have income or a loss from a farm property listed on Schedule F of your income tax return, you must produce a letter of explanation stating the farm isn’t on the property you’re buying. Your letter also must include the address of the farm that’s tied to the income or loss. This is necessary since the underwriter can’t get this information about the property from your tax documents.

When determining the value of the home, another structure on the property can’t be the primary reason for that value. It’s worth noting here that some lenders, including Rocket Mortgage®, don’t finance farms.

You have long gaps in your employment history

You’ll need a steady and reliable income to keep up with the payments on a home loan, so long gaps in unemployment may make you seem like a risky borrower. For VA and jumbo loans, your lender may require a letter of explanation for gaps in unemployment within the past 2 years. A letter may only be required when gaps in employment are greater than 30 or 60 days, depending on the type of loan.

You’ll need to explain what caused any gaps, which can come about for various seasons that include:

• Having a child
• A return to education
• Caring for a family member
• A business failure
• Downsizing
• Mass layoffs due to the COVID-19 pandemic
• Being self-employed
• Seasonal work

If you still met your financial obligations during this time, note that information, too.

Remember that an explanation letter is a tool that helps demonstrate you’re a qualified buyer. By addressing any worries about your financial history, you can increase your chances of getting approved for a mortgage and start hunting for your new home sooner.

How to write a letter of explanation for a mortgage

Letters of explanation are a common part of the mortgage application process. Make sure your letter of explanation includes:

• That day’s date
• Your lender’s name
• Your lender’s phone number and physical address
• A subject line that starts with “RE:” and has your name, the number of your application, and any other identifying info
• One or more paragraphs that provide information the lender asked for (Be as detailed as possible is necessary and include dates, dollar amounts, account numbers, etc.)
• Any supporting documents that provide identification and back up your claims (copies of bills of sale, title transfers, marriage licenses, etc.)
• Your full legal name as it appears on your mortgage application, signed and printed
• Your spouse or partner’s name if they’re on the loan application with you
• Your full mailing address and 10-digit phone number
• A polite closing

It’s best when writing a letter of explanation to make it short and to the point. You’ll want it to provide the recipient with the information they need, however. Be clear and offer as much relevant detail as possible since the person reading the letter will need to understand your situation. Still, avoid including unnecessary details or answering questions the underwriter never asked. Use a polite tone but try not to be overly friendly or use emotional language.

After you finish writing the letter, edit for typos or grammatical errors. Send the letter in a timely manner to keep your mortgage application on track.

Explanation Letter Template

Below is a sample letter of explanation you can use as a template, if you wish,  to write an explanation letter of your own.

July 15, 2023

Sample Lending Company

123 Lending Lane

Brooklyn, NY 11207

000-000-0000

RE: Jessica Smith’s Mortgage Loan Application

To Whom It May Concern:

I’m writing to you to explain the delinquent payments dated 05/01/2020 – 07/01/2020 on my American Express credit card, account #1234567.

On April 15, 2020, I was laid off from my job due to the COVID-19 pandemic. Because I was unemployed, I was unable to make my minimum credit card payments for this account for May and June. I started a new job on June 20, 2020 and was able to make my July payment.

I’m still working at the same company today and, since July 1, 2020, I have not been late on, or missed, any payment on this credit card account. Enclosed is a copy of my statements from July 1, 2020 until now as proof of my good standing and on-time payments with this account.

Sincerely,

Jessica Smith

150 Same Drive

Brooklyn, NY 11207

000-000-0000

How underwriters will use a letter of explanation

Mortgage underwriters are responsible for verifying your financial information and determining whether you qualify for a loan. If they come across anything in your application that raises questions, they may request a letter of explanation to fill in the gaps.

Underwriters typically review:

• Bank statements
• Tax returns
• Pay stubs
• Credit reports
• Employment history
• Gift letters, if applicable
• Letters of explanation for inconsistencies or negative items

A well-written letter of explanation can move your application forward by giving underwriters the context they need to understand your financial situation. It can show that past issues were temporary and that you’ve taken steps to prevent them from happening again. A strong letter may improve your chances of approval for many types of mortgages, including conventional, FHA, VA, and USDA loans.

FAQ

Below, you’ll find answers to frequently asked questions about letters of explanation and the process of composing a letter of explanation.

What is a late payment letter of explanation?

When applying for a mortgage loan, this type of letter explains the circumstances surrounding any missing or late payments reflected in your credit history and what you’ll do to avoid these issues moving forward.

What if my letter of explanation is rejected?

If your letter of explanation is rejected by the underwriter, consider exploring the following three options:

• Writing a new letter that provides further explanation and additional documentation
• Applying for a home loan with a different mortgage lender
• Reapplying after resolving the issues

Do I always need a letter of explanation?

No. In general, a letter of explanation is only required when the underwriter requests clarification on aspects of your financial history.

The bottom line: Explanation letters can boost your chances of mortgage approval

A lender wants to make sure you are in the best possible position to take on the financial responsibility of a mortgage because lenders like to be confident, they are making a wise investment. Certain events can trigger a red flag for the underwriter, so your lender may ask you for a letter of explanation to help ease concerns.

There are a few reasons you or a third party may need to produce this letter, depending on the lender you are working with and the type of loan you are getting. If you have experienced any of the examples above, you may want to prepare a letter of explanation now to ensure a smooth process.

Writing this letter is often simpler than it sounds. All you need to do is clearly explain the situation, provide any relevant dates, and include any documentation that supports your explanation. Being honest and direct can help your lender better understand your financial picture and keep your loan on track.

Ready to take the first step in your home buying journey? Start a mortgage application with Rocket Mortgage today to see how much home you qualify for.