A letter of explanation (LOE) is a simple document that provides additional context to a lender about specific items in your financial history. It is a personalized statement that helps clarify any red flags or irregularities that may appear in your financial records. These letters are typically requested when there are discrepancies or unusual activity in your financial records that require clarification.
Lenders use this document as a tool to better understand your financial behavior and to assess the risk associated with your mortgage application. Although it may seem like an additional hurdle, it’s an opportunity to present your case and provide assurance to the lender that you are a responsible borrower. Understanding the importance of a letter of explanation can significantly enhance your ability to successfully navigate the mortgage process.
Common Reasons for a Letter of Explanation
Lenders may ask for a letter of explanation for several reasons, including:
- Credit Inquiries: Multiple credit inquiries in a short period may raise concerns about your financial stability. Lenders worry that you might be taking on new debts that could affect your ability to repay the mortgage. Explaining the reason behind these inquiries can help mitigate such concerns.
- Employment Gaps: Unexplained periods without employment may require clarification. Lenders want to ensure you have a stable income stream. Addressing why you had a gap and how you have since secured stable employment can ease their worries.
- Large Deposits: Significant amounts of money deposited into your accounts may need explanation, especially if they’re not from a regular income source. Lenders need to confirm that such deposits are legal and not borrowed funds that could impact your financial obligations.
- Address Discrepancies: Inconsistent addresses on documents may require an explanation. Lenders need to verify your residency and any discrepancies can raise flags about your stability or identity.
How to Write a Letter of Explanation
Writing a letter of explanation is straightforward. It should be concise, clear, and honest. Here’s a basic structure to follow:
- Date: Begin with the date at the top of the page. This establishes the timeline and context for your explanation.
- Lender’s Information: Include the name and address of your lender. This ensures the letter reaches the correct recipient and is properly filed with your application.
- Subject Line: Clearly state the purpose, such as “Letter of Explanation for Mortgage Application.” This helps in categorizing and prioritizing your letter.
- Greeting: Use a formal salutation like “Dear Lender’s Name,”. Addressing the lender directly establishes a respectful tone.
- Body: Briefly explain the situation. Be direct and honest. Use simple language to ensure clarity and prevent misunderstandings.
- Closing: Offer to provide additional information or documentation if needed. This shows your willingness to cooperate and resolve any issues.
- Signature: Sign the letter with your full name. This personal touch adds authenticity to your communication.
Tips for an Effective Letter
- Be Honest: Always provide truthful information. Misleading your lender can have serious consequences. Transparency builds trust and increases the likelihood of a favorable outcome.
- Keep It Simple: Avoid jargon and complex explanations. Clear and concise communication is key. The goal is to make it easy for the lender to understand your situation without unnecessary complexity.
- Attach Documentation: If possible, include any supporting documents that validate your explanation. This substantiates your claims and provides evidence to back up your statements.
Sample Letters of Explanation
Below are some sample letters to guide you in drafting your own explanation letter. These samples serve as templates that you can adapt to fit your specific circumstances and provide a framework for crafting an effective letter.
Sample 1: Credit Inquiry Explanation
Date: [Insert Date]
Your Lender’s NameYour Lender’s AddressCity, State, ZIP Code
Subject: Letter of Explanation for Mortgage Application – Credit Inquiries
Dear Lender’s Name,
I am writing to provide clarification regarding the recent credit inquiries on my report. On Date, I applied for a new credit card to take advantage of a promotional offer. Additionally, I applied for a car loan on Date as I needed a reliable vehicle for work.
Please note that these inquiries have not resulted in excessive debt or impacted my ability to make mortgage payments. I have attached supporting documentation for your review. By addressing these inquiries directly, I hope to alleviate any concerns about my financial stability.
Thank you for your understanding. Please let me know if you require any further information. I am committed to ensuring a smooth mortgage application process.
Sincerely,
Your Full Name
Sample 2: Employment Gap Explanation
Date: [Insert Date]
Your Lender’s NameYour Lender’s AddressCity, State, ZIP Code
Subject: Letter of Explanation for Mortgage Application – Employment Gap
Dear Lender’s Name,
I am writing to explain the gap in my employment history from Start Date to End Date. During this period, I was transitioning between jobs and took the opportunity to further my education by enrolling in a certification course related to my field. This decision was strategic, aimed at enhancing my skills and improving my long-term career prospects.
I have since secured a stable position with Current Employer and am confident in my ability to meet the mortgage payment requirements. I have attached my current employment verification for your records. This employment not only stabilizes my income but also reflects my commitment to professional growth.
Thank you for your consideration. Please feel free to contact me if you need additional information. I appreciate your understanding and look forward to your favorable response.
Sincerely,
Your Full Name
Sample 3: Large Deposit Explanation
Date: [Insert Date]
Your Lender’s NameYour Lender’s AddressCity, State, ZIP Code
Subject: Letter of Explanation for Mortgage Application – Large Deposit
Dear Lender’s Name,
I am writing to explain a large deposit in my checking account on Date. The deposit of $Amount was a gift from my family to assist with my home purchase. I have included a gift letter from my family member and a bank statement showing the deposit. This gift was a generous support gesture and not a loan, ensuring there is no repayment obligation.
This deposit will not affect my ability to manage mortgage payments, as it is a one-time gift rather than a loan. I understand the need for clarity regarding large transactions and have provided all necessary documentation to verify this deposit’s legitimacy.
Thank you for your understanding. Please let me know if you need further information or documentation. Your assistance in this process is greatly appreciated.
Sincerely,
Your Full Name
Final Thoughts
A letter of explanation can be a powerful tool in the mortgage approval process. By providing clear, honest information, you can alleviate any concerns your lender may have and demonstrate your readiness to meet mortgage obligations. This proactive approach not only clarifies potential misunderstandings but also showcases your commitment to transparency and responsibility.
Remember, every financial situation is unique, and your letter should reflect your personal circumstances. Use the samples provided as a guide, but ensure your final letter accurately represents your situation. Tailoring your letter to your specific context will make it more effective and convincing.
If you’re uncertain about how to address specific issues, consider consulting with a financial advisor or mortgage professional who can offer tailored advice. With the right approach, your mortgage application can proceed smoothly and successfully. A well-crafted letter of explanation is an investment in your financial future and can significantly improve your chances of securing a mortgage.