You might feel panicked when an underwriter asks you for a Letter of Explanation. You might wonder why they need it? What if you write it wrong? Will you lose your loan?
First, know that it’s common to have to write a letter for one reason or another. It’s a way to explain special circumstances that upon first glance might cause a lender to turn you down for a loan. Think of it as a way to save your approval. The lender uses your letter and any supporting documentation to help you get the loan you want, whether it’s backed by the government or Fannie Mae/Freddie Mac are investing in it.
The Reason Lenders Need Letters of Explanation
There are usually a few common reasons lenders need a Letter of Explanation:
- An issue with your credit
- An issue with your employment
- A previous address that looks suspicious on your credit report
Remember, lenders are held to the requirements of the program they offer. FHA, VA, USDA, and conventional entities all have their own guidelines. If you come to the lender with something outside of those guidelines, he has two choices: deny your application or ask for an explanation of certain circumstances. That’s why an LOX can be a good thing – it gives you a second chance.
Underwriters can ask for a Letter of Explanation for just about any reason. But, there are some common scenarios that happen more often than others:
- Strange activity on your bank statements, such as large deposits or withdrawals
- Owning a joint bank account with someone that is not on the loan
- Derogatory information on your credit history, such as late payments or bankruptcies
- Red flags on your bank statements, such as NSF fees
- Late housing payments
- High debt ratio
Basically, lenders look for anything that doesn’t make sense. If there’s a question, you can bet they are going to ask for proof of the situation in writing.
How Letters of Explanation Help
As we discussed above, a LOX can be like a second chance. It gives you a chance to give your side of the story. For example, on paper, it looks really bad that you missed a housing payment. But, if you had extenuating circumstances, such as being stuck in the hospital for several weeks, you can prove it to the lender. You can further prove that the late payment has not happened again and that you are back to your old ‘good habits.’
In the end, you are dealing with a human being that understands. While at first, you might be fighting a computer’s algorithms and dealing with a rather black and white approval or denial, an underwriter will look at your file eventually. If you can plead with that person to understand your case, you might get yourself a loan.
How to Write a Letter of Explanation
Perhaps the most anxiety-provoking part of the Letter of Explanation is actually writing it. What do underwriters want to see? What would make the deal fall through? These are likely questions going through your head.
There’s one simple rule you must follow, though – keep it simple. Don’t provide more information than necessary. Answer the question in a few sentences and nothing more. This isn’t a test that you will pass or fail. It’s just a way for you to let the lender know what happened and why. Stick to the facts and back it up with any proof that you can.
In fact, it’s the proof that will really make or break your loan approval. For example, let’s say you write a letter stating you were in the hospital because of a surgery you had to have. If you don’t have some type of proof that hospital stay, the lender has no concrete proof you are telling the truth. Bills or even a letter from your physician stating that you were in the hospital during those days may suffice. Of course, if we’re talking about paying your bills late because of the hospital stay, you may also want to show your paystubs from those periods, showing that your income was lacking because of the medical issue.
Again, the documents will speak for themselves. The few sentences in your letter simply reiterate what you told the loan officer. The difference is that you sign and date this letter – it’s a sign of your agreement that you are telling the truth.
Don’t get nervous if your underwriter asks you for a Letter of Explanation. It’s just a way to make sure beyond a reasonable doubt that you are a good risk. If you are telling the truth and have evidence to back it up, you have nothing to worry about.