What is a Letter of Explanation?

A Letter of Explanation is a document that clarifies details within a home buyer’s mortgage application that may raise questions with their mortgage lender.

A Longer Definition: Letter of Explanation

A Letter of Explanation is a way for home buyers to clarify aspects of their mortgage application that may not be clear to a lender. The common mortgage acronym for Letter of Explanation is LOE.

Lenders request the buyers write a letter of explanation whenever there’s unusual or unclear information in the context of the mortgage application, including:

1. Explanations for gaps in employment
2. Explanations for abrupt changes in income
3. Explanations for many hard credit inquiries

Letters of explanation describe irregularities in a mortgage application and give mortgage lenders context, which makes it easier to get the mortgage approved.

A well-written LOE can be the difference between a lender accepting or rejecting a mortgage application, especially where the home buyer’s credit profile does not neatly fit into standard mortgage underwriting criteria.

Letter of Explanation: A Real World Example

Imagine a first-time home buyer who recently applied for a mortgage. In their mortgage application, there’s a six-month period where the home buyer was unemployed.

Upon reviewing her application, the lender is concerned about this six-month employment gap, which may indicate financial instability.

So, the buyer writes a three-sentence Letter of Explanation, clarifying that during the period in question, they took time off work to care for an ailing family member and had sufficient savings to manage her finances. They also provided evidence of re-employment and steady income after that.

The letter of explanation helps the lender understand the buyer’s situation, removing their concerns about their financial stability.

Common Questions About Letter of Explanation

What should be included in a Letter of Explanation?

A Letter of Explanation should clearly, concisely, and honestly address the specific issue or question raised by the lender. It should include relevant dates, specific details, and any supporting documentation when appropriate.

How long should a Letter of Explanation be?

The length of a Letter of Explanation can vary, but it should be as brief as possible while fully addressing the lender’s concerns. Usually, a few sentences are sufficient.

What types of mortgages require LOEs?

A letter of explanation could be required for any mortgage type, including conventional loans, FHA loans, USDA loans, VA loans, and others.

Is a Letter of Explanation legally binding?

No, a Letter of Explanation is not legally binding. It is a personal, explanatory document that gives context to a home buyer’s financial situation. However, it is crucial to be honest and accurate in the information provided, as any false statement can have serious consequences, including affecting the mortgage application’s outcome or leading to legal repercussions.

Does a Letter of Explanation guarantee mortgage approval?

No, a Letter of Explanation does not guarantee mortgage approval. However, it provides clarity to the lender, which can positively influence their decision.