Mortgage Loan Q&A Series: “What is a Mortgage Loan Explanation Letter?”
If you’re currently going through the joyous process of getting a home loan, you may have been asked to provide a “letter of explanation,” otherwise known as an LOE.
In short, it allows you to add a little more color to what the underwriter may feel is a complicated case.
You can think of the mortgage lender as an expert in home loans, someone hired to uncover anything unusual that may appear in your loan file when the documentation is submitted.
Sure, the required paperwork may all be there and your credit score and DTI ratio may be fine, but it’s the underwriter’s job to read between the lines.
Otherwise, mortgage applications could really go through automated underwriting systems and that would be the end of it. We wouldn’t need humans anymore.
This is not the case, at least not yet, so expect your mortgage application to be scrutinized and be prepared to “explain yourself” if anything comes up that the underwriter feels needs explaining.
You should definitely not argue with the insurer or be defiant, it is never a very good strategy. When I worked for a lender, I always went out of my way to be nice to the underwriters. You should too.
Ultimately, the sooner you can get them the answers they need, the sooner you can close your mortgage and move on with your life.
What is the purpose of an explanatory letter? It depends
- You have recently changed jobs
- You have unusual deposit activity on your bank account
- Recent large deposits
- Gap in employment
- You have a declining income
- Your source of income must be explained (self-employed borrowers)
- Undisclosed payments (liabilities) from your bank account
- You have student loans
- New accounts on your credit report (newly opened credit cards)
- Credit inquiries on your credit report
- Other addresses on your credit report
- Other names on your credit report
- Notes on your credit report that require explanation
- Previous offenses to be reviewed
- Occupancy issues (is this really your primary residence?)
When you apply for a mortgage, you are either approved or rejected. If you get the green light, the approval will actually be a conditional loan approval.
That means you still have work to do to get to the funding table. This involves the submission of both pre-conditions (PTD) and pre-financing conditions (PTF) for final approval.
One of these PTD conditions might be a letter of explanation to explain something the underwriter needs more clarity on, such as a recent job change or an unusually large deposit.
It’s that simple. The LOE is written and submitted by the borrower to provide clarification.
Explanation requirements will vary from lender to lender
There are many situations where a letter of explanation may be required, too many to really list. And probably new ones generated daily. But I mentioned a lot above.
In addition, the need for an LOE will vary depending on the mortgage institution. Not all of them will require one depending on the situation at hand.
Ultimately, some lenders and underwriters will be more stringent and/or cautious than others.
That being said, some of the more common ones tend to have to do with assets aka money and where it came from.
For example, if you have provided bank statements to meet one of your loan conditions, the underwriter may flag some of the transactions or payments upon review.
Maybe there’s a $10,000 deposit in the account, which doesn’t quite match what you’re earning in salary. It seems a little out of place, even though it’s totally legit.
The underwriter may ask you to explain the deposit to ensure it is kosher and not from a non-qualified source.
Let’s say money came from one of your other accounts and you simply transferred the money between accounts.
You will provide an LOE to the underwriter explaining this. But that would not be the end of the story. If your LOE included information about another bank account, they would certainly also have statements for that bank account to review the activity to make sure everything matches.
Sometimes, if you are lucky, you may even be asked to provide another letter of explanation due to the content of your previous LOE. Actually a LOE for a LOE.
As you can see, things can get really murky in a hurry, so it’s best to keep things in order before you apply for a mortgage.
It is rare that mortgage lenders are completely satisfied with everything that is presented to them. And the more you put in front of them, the more chances they have to ask for, well, more.
[Who are all the people involved in the mortgage loan process?]
Letter of explanation Template for mortgage loan
- Include a basic headline and greeting to make it official
- A short explanation to clear up the confusion (short and sweet!)
- Sign and date it
- And provide necessary documentation to back up the letter if needed
- See example of the letter of explanation below
You may be wondering how to write a cover letter (assuming you’re asked for one).
The screenshot above is an example of an LOE template I created in a matter of minutes, in case you’re wondering.
The good news is that creating one is super easy. It’s basically just a Word document (or comparable program) with a small heading and then a short paragraph or two for clarity, followed by your signature and the date it was written.
There are no set formatting guidelines for an LOE, so you can put the date at the top or bottom and leave out the salutation if you like. It doesn’t really matter that much as long as the most important details are there.
You can put “Letter of Explanation” or “Letter of Explanation” at the very top, followed by a brief description of the issue at hand, then your name/signature/date. It really doesn’t take much effort to create one.
That’s the easy part. The hard part can be providing supporting documentation or making your case if you don’t have a readily available explanation.
What you write in these few paragraphs is very important, so don’t rush the central message you are trying to convey.
In short, whatever you explain must make sense, and more importantly, put the underwriter at ease. They need to feel comfortable approving your loan, and whatever required the LOE to begin with made them worried.
It’s certainly not the end of the world, and often just hearing in your own words that X happened because of Y is good enough, with the supporting documentation to prove it. Taking your word for it is generally not acceptable.
Either way, don’t be afraid to ask the loan officer or mortgage broker exactly what they want to hear or how you should format the letter. If you have questions or are unsure, ask before submitting documents that could get you into even more trouble.
Keep it simple to avoid LOEs in the first place
- Think about what might happen to the underwriter in advance
- Take action to address these issues before applying for a mortgage
- So an LOE is not necessary to begin with
- It can make life much easier and improve the chances of long recognition
Your best move may be to get all your ducks in a row long before you apply for a mortgage.
For example, if you need to move some money around, it may be wise to make these transfers 60+ days before the loan application.
Mortgage lenders typically only ask for your last two monthly bank statements, so activity that occurred before that shouldn’t be visible.
Any financial activity that takes place for a few months prior to the application may just complicate matters and require more paperwork. And with that, scrutiny.
If your accounts are relatively intact and nothing out of the ordinary is present, you can ideally skate through without any further conditions.
The same goes for opening new accounts – if you don’t have to, don’t. It just makes life more complicated.
If you’re thinking of changing jobs, maybe wait. Anything that you think might sound shady or complicated may be best avoided for now. Or at least until the loan funds!
At the end of the day, LOEs aren’t really that difficult to arrange or complete, but they can lead to bigger problems if you don’t have good answers!
As mentioned, do your best to play ball and make it nice with everyone, whether it’s the loan officer, processor or underwriter, to avoid unnecessary drama.
Finally, if you are asked to provide a letter of explanation and are not sure why, speak to your mortgage broker or loan officer directly.
I often get emails and comments about why one is requested. Rather than asking me, it’s probably a better idea to ask your broker or representative of the bank to get to the bottom of it as soon as possible.
Read on: What do mortgage loan officers do?
Before creating this site, I worked as an account manager for a wholesale mortgage lender in Los Angeles. My hands-on experience in the early 2000s inspired me to start writing about mortgages 18 years ago to help potential (and existing) homebuyers better navigate the home loan process. Follow me on Twitter for hot takes.
