Letter of Explanation: What is it and when do you need one?

Quick insights

• A Letter of Explanation (LOE) is a document future homebuyers write to explain any concerning aspects of their financial history to lenders, such as gaps in employment or bank transactions.
• Some mortgage providers may have unique requirements that necessitate a Letter of Explanation. This is usually dependent on their risk tolerance and internal policies.
• By communicating openly and writing a captivating LOE, you can navigate the mortgage application process with greater confidence and increase your chances of securing a home loan.

Have you ever been asked to provide a “letter of explanation” and found yourself at a loss on what is it and why lenders might require it? You’re not alone. Whether you’re applying for a loan, seeking employment or navigating other time-sensitive scenarios, understanding the objective and process behind these documents can be essential. Crafting an effective Letter of Explanation (LOE) can make all the difference. In this article, we will explore the intricacies of letters of explanation, uncover why and when they’re needed and how to craft one that is precise, concise and leaves a favorable impression.

What is a letter of explanation?

Imagine you’re navigating the maze of mortgage approvals with a home lending advisor, and you encounter two key clues: “Letter of Explanation Mortgage” and “What is LOE?” Think of LOE as your golden opportunity to shine a light on trouble areas in your financial history before underwriters start to investigate.

Simply put, a letter of explanation for a mortgage is a document prospective homebuyers provide to lenders addressing any red flags or uncertainties that may arise during the mortgage underwriting process. This letter proactively allows you to explain any bumps you may have encountered on your financial journey such as gaps in employment or substantial withdrawals from your bank account. Done correctly (and timely) an LOE could be your chance to hopefully speed up the process of getting your mortgage approved.

Who needs a letter of explanation?

There are many circumstances that can trigger the need for first-time homebuyers to provide a letter of explanation. Let's discuss the specifics:

• Requirements of specific lenders: While a LOE may not be universal across all mortgage providers, homebuyers should be aFware that specific lenders may have unique documentation requirements. Mortgage providers offering niche loan programs, such as government-backed loans for first-time homebuyers, may have stricter documentation requirements. This can include Federal Housing Administration (FHA) loansfha-mentioned-hl000046 and Veterans Affairs (VA) loansva-hl000068.
• Jumbo loan request: A jumbo loanjumbo-hl000051 is a type of mortgage loan that exceeds conforming loan limits. When applying for a jumbo loan, lenders may require more detailed documentation, including a Letter of Explanation, to assess potential risk.
• Negative events on your credit report: Adverse situations such as late payments or bankruptcy can impact your mortgage application. A Letter of Explanation for late payments may be required to provide added context for these events.
• Long gaps in work history: A prolonged period of unemployment or gaps may raise concerns about your ability to repay the loan.
• Large bank transactions: Large deposits or withdrawals from your bank account can raise red flags for lenders. This might indicate potential financial instability.
• Unsteady source of income: If your income fluctuates often, lenders may seek additional assurance of your ability to meet monthly mortgage payments.

How to write a letter of explanation

Here are a few practical tips on how to write an explanation letter:

• Include identifying information: Start by identifying yourself and the intent of the letter. Include your name, contact information, loan application number and any other pertinent information.
• Provide supporting documentation: Make sure you bring supporting documentation to back up your explanation. For instance, if you are explaining a significant bank deposit, you may want to bring a bank statement to verify the source of funds.
• Keep it succinct: It’s important to provide sufficient details and keep your LOE concise. Avoid including irrelevant information that could detract from your key points.
• Emphasize the circumstances that led to the issue: Clearly and concisely explain the circumstances that led to the issue being raised by the mortgage lender.
• Highlight improvement: Demonstrate how you’ve taken steps to address the issue and improve your financial situation. This can include actions like reducing debt or finding stable employment.
• Proofread your letter: Take some time to proofread your letter before submitting it to the mortgage lender.
• Keep the tone professional: Maintain a respectful and courteous tone through the Letter of Explanation. Remember, the goal is to provide a compelling explanation that helps your case.

In summary

A well-written Letter of Explanation can be a powerful tool in your journey toward becoming a homeowner. As you prepare your Letter of Explanation, include identifying information, supporting documentation and highlighting improvements in your financial situation. By providing clarity and addressing any discrepancies in your financial history, you can build trust with mortgage lenders which could potentially help increase the likelihood of mortgage approval.