To qualify for a loan, you’ll need to have good credit, a decent debt-to-income ratio, steady employment, and cash reserves. If you’re missing any of things—or many others—your bank may ask for a letter of explanation (LOE) for the mortgage. This is an opportunity to tell your lender more details about your financial situation so they can determine if they should lend to you despite any shortcomings. Learn more about why you need a letter of explanation and how to draft one so that it has a better chance of success.
Why Do You Need a Letter of Explanation?
There are plenty of reasons an underwriter might ask for a letter of explanation from you. They may include:
A long gap in your employment historyA rent-free living situationNegative entries on your credit reportLong gaps in your employmentChange in incomeA job changeA large sum of money deposited into your bank account
These are a few examples of common reasons why your bank may ask for a letter of explanation, but banks may ask for an LOE for many other reasons. If something about your financial situation raises concern, your underwriter may second-guess your application and may request some more details before deciding whether to approve you for a mortgage.
Negative Items on Credit Report
Missed payments, high credit utilization, or other factors that can lower your credit score can give your lender cause for concern. After all, your credit score indicates your creditworthiness, or how likely you are to repay. However, rather than rejecting you outright, your lender may ask you more about them. You might have a good reason for negative items on your credit report and an LOE will let you clarify that and explain the situation. For example, perhaps a report of a missed payment was a mistake.
Living Rent-Free
Have you been staying with friends or family to save up money for a down payment? Lack of a payment history when it comes to your primary residence may be a flag for some underwriters because they want evidence you can reliably make monthly payments. In this case, an LOE should come from the person who owns the home or property where you are living. They can confirm that you have been living in their home rent-free and they should state for how long.
Long Gaps in Employment
Banks want to be sure that you will be able to repay your loan, which means income stability is very important. If you’ve gone long periods without working, they’ll want to know why. Typically (and depending on the lender and type of loan) a bank will ask for an LOE if you have been unemployed for 30 to 60 days in the past two years. You may have a good reason for not being employed for a long period of time. Maternity leave, time for education, a business failure, time off to care for a loved one, among others are all situations you can explain in an LOE.
Change in Income
Again, banks want to see income stability. So, if you’ve changed jobs or otherwise have unexplained sources of income, the underwriter may wonder why. Perhaps you took a new job for higher income, or were attracted to better benefits at another company. You can detail the reason behind those income changes in the letter.
Letter of Explanation Example
Writing an LOE is very straightforward. The goal of the letter is to be factual, clear, concise, and polite. Remember, an LOE is simply a clarification that allows both you and your underwriter to address any concerns with your application. Use the template below to create your own LOE by replacing the details with your own: January 1, 2022 Example Lending Company 123 Street Address Example City, ZIP CODE (999) 555-5055 RE: YOUR NAME Loan Number: 557904, LOE for gap in employment To Whom It May Concern: I am writing to you in regards to the letter of explanation you have requested regarding my gap in employment. On the dates concerned, I was studying full-time at the University of California Los Angeles. I have attached my academic records to verify this. Please let me know if you require any further information. Thank you, YOUR NAME YOUR ADDRESS LINE 1 YOUR ADDRESS LINE 2
