Why Do I Need To Provide A Letter Of Explanation?
Secondary authorities that own or back the loan may also require a letter of explanation.
Many of their guidelines dictate that the lender must get a mortgage letter of explanation for certain items on a borrower’s report. Secondary authorities that impose such underwriting standards include:
- The Federal Housing Administration (for FHA loans)
- The Department of Veterans Affairs (for VA loans)
- Fannie Mae or Freddie Mac (for conventional loans)
Lenders offering jumbo loans may have even more qualification standards.
Next, we’ll review examples of reasons you may be required to provide a letter of explanation.
You Have Negative Items On Your Credit Report
Lenders need to know you have no trouble managing your finances. Negative items on your credit report can alarm underwriters, who might assume you have difficulty paying your bills. You may need to provide a letter of explanation for any negative items on your credit report, including:
- Missed payments
- Defaulted loans
- Foreclosures
- Repossessions
Letters of explanation addressing these issues should include:
- An explanation of the negative event
- The date it happened
- The name of the creditor
- Your account number
- Your signature and date (if typed or hand-written)
It should also include an explanation of why you don’t foresee this problem happening again.
You’re Living Rent-Free
Rent or mortgage payment history shows a lender whether you’re capable of paying your housing costs on time. If you’ve been living for free somewhere, like your parents’ home, you’ll need to prove that to your lender with a letter of explanation from the homeowner, not you.
In the letter, the homeowner should state that you’re currently living in their home rent-free and indicate how long you’ve been doing so. Make sure they also sign and date the letter.
You Have Income Or Loss From A Farm Property
If you have an income or loss from a farm property listed on Schedule F of your income tax returns, you must produce a letter of explanation stating the farm isn’t on the property you’re buying. The LOE must also include the address of the farm that’s tied to the income or loss. This is necessary since the underwriter can’t get this information from your tax documents.
When determining the value of the home, another structure on the property can’t be the primary reason for that value. It’s worth noting here that some lenders, including Rocket Mortgage®, don’t finance farms.
You Have Long Gaps In Your Employment History
You’ll need a steady and reliable income to keep up with the payments on a home loan, so long gaps in unemployment may make you seem like a risky borrower. For VA and jumbo loans, your lender may require a letter of explanation for gaps in unemployment within the last 2 years. A letter may only be required when gaps in employment are greater than 30 or 60 days, depending on the type of loan.
You’ll need to explain what caused any gaps, which can come about for various seasons that include:
- Having a child
- A return to education
- Caring for a family member
- A business failure
- Downsizing
- Mass layoffs due to the COVID-19 pandemic
- Being self-employed
- Seasonal work
If you still met your financial obligations during this time, note that information, too.
Remember that an explanation letter is ultimately a tool that helps demonstrate you’re a qualified buyer. By addressing any worries about your financial history, you can increase your chances of getting approved for a mortgage and start hunting for your new home sooner.
