When you apply for a mortgageYou’ll need to hand over a skyscraper’s worth of documentation: your bank statements, tax returns, pay stubs, your debt details and more. Depending on your financial situation, your lender may also ask you for a letter of explanation. Here is what it means.
What is a letter of explanation?
Mortgage lenders ask you to write a cover letter so they can better understand your finances when deciding whether to approve you for a loan. While your lender’s underwriting department looks at factors like your credit rating and income, these numbers may not paint the full picture of you as a borrower. A letter of explanation helps complete this picture, giving lenders a better understanding of your ability to pay off a mortgage.
Why do you need a mortgage cover letter?
When lenders review your loan application, their goal is to make sure that you will be able to monthly mortgage payments. Imagine loaning someone hundreds of thousands of dollars – you would probably ask for concrete evidence that you would end up getting that money back as well.
If your lender asks you to submit a letter of explanation, the request is likely related to a specific piece of information in your request that raised a red flag. A letter of explanation is simply one way to help resolve this red flag, which may include:
- A change of job, in particular in the period preceding the closure
- Problems from your past that show up on your credit report
- A new credit card opening or a high credit card balance
- A major transaction (withdrawal or deposit) on your bank account
- An unstable source of income – if you are self employed or an independent contractor, the lender may want a better idea of your income
It may be a good idea to proactively submit a letter of explanation, especially if you are aware of a potential red flag. Put yourself in the shoes of someone reviewing your application: is there something that might make you scratch your head?
Let’s say you took eight months off last year to care for an elderly relative. For the lender who looked at your bank statements, you were unemployed. With a letter of explanation, you can help your lender understand that the decision to temporarily stop working was voluntary. This could alleviate the lender’s concerns about another period of unemployment in the near future.
How to write a letter of explanation
If you need to submit a letter of explanation, be sure to include all the key details of a traditional business letter:
- The name and address of the lender
- Your name and request number
- The date you submit the letter and the expected closing date (if you know it)
- A brief statement that helps an underwriter fully understand your situation with respect to the cause of concern
- Your current mailing address and phone number
Explanation letter template
Although the format of your letter will depend on your situation, you can use this cover letter template as a sample guide:
Name of lender
City, state and zip code of the lender
Lender’s phone number
RE: Your name and application number
Dear loan specialist:
I am writing to explain the deposit in my [bank name]checking account of $ 7,500 on January 3. This deposit was a gift from my father to help cover part of the down payment and closing costs for the purchase of my home. I attach another letter from my father, which states that this is a gift and that he does not expect this money to be refunded.
I am available to answer any additional questions and look forward to our scheduled closing date of April 30th.
Your postal address
Your city, state and zip code
Your phone number
If you submitted an application with a co-signer, you will also need to include the name of the co-signer on the letter.
It is important to note that you can make a cover letter more convincing with additional documents. In the example above, the borrower has included a gift letter from their father who backs the claim that the money will not need to be paid back.
Whatever your reason for writing a letter of explanation, ask yourself if there are other documents that can support your request and, if you have, submit them.
Tips for writing a letter of explanation
If you need to write a letter of explanation, there is no need to panic. Follow these three steps to set up a solid support for your application:
1. Be honest
The adage of “the truth will set you free” can be changed to “the truth will help you get approved.” If your lender asks for an explanation, sharing the facts is crucial.
“When mortgage applicants find themselves in situations that they believe could negatively impact a lending decision, the best advice is just to be honest,” said Pete Boomer, executive vice president of PNC Bank. “It is in their best interest to fully disclose to the lender the event or events that could affect a decision to lend money.”
2. Be formal
This letter is not the occasional email you send to your colleague about lunch. The recipient holds the keys to a new chapter in your life: become owner. With that in mind, approach your letter with an increased degree of formality. Take pride in your former English teachers with impeccable professional-level spelling, capitalization and construction.
3. Be brief
You don’t have to write a novel. Keep the letter concise, focusing only on the details that need to be covered. Remember that lenders deal with many requests. Rather than making their job harder with dense text, focus only on the information they need to review in order to bring your application closer to approval.
Once you submit a letter of explanation, you will need to wait to hear from your lender. Make sure to respond promptly to any additional requests. Lenders value borrowers who treat the home buying process with the importance it deserves. While you wait, make sure you’re ready for the last piece of the puzzle: closing. here is what you can expect in the closing process.