Reader question: “We have been asked to write a letter of explanation for our mortgage lender’s underwriter, regarding a bank overdraft fee. They were unable to provide a sample or template for a mortgage letter of explanation, but they did say to keep it simple. Why do mortgage lenders ask for letters of explanation, and do you have a sample template we can use to get started?”
The letter of explanation (or LOE for short) is a common part of the mortgage underwriting and documentation process. Some borrowers panic when an underwriter asks for such a letter, because they think the loan is going to be denied. But that’s not always true.
In fact, a request for an LOE is usually a good thing, because it means the underwriter is trying to document his way around a certain issue so he can clear the loan for funding. So you could think of it as moving one step closer to closing. The key is to deal with it in a timely manner.
Mortgage Letter of Explanation (LOE) Sample
Simplicity is key when writing a letter of explanation for a mortgage underwriter. All you really have to do is explain, in clear and simple language, what the lender wants to know.
- If they are inquiring about an overdraft fee, tell them why it happened and whatever extenuating circumstances might have been involved. You could also explain what steps you’ve taken to avoid it happening again.
- If the lender wants an LOE to better understand a recent bank withdrawal, simply provide the details of that transaction and why it was necessary.
Here is a sample template for a mortgage letter of explanation:
When writing a mortgage letter of explanation, be as specific as possible and include actual dates and dollar amounts. If your LOE relates to a late payment or some other negative issue, you might want to describe the steps you’ve taken to ensure it won’t happen again.
Why Lenders Ask for Them
So, why do mortgage lenders ask for letters of explanation regarding certain financial issues?
It usually has to do with credit and underwriting requirements that are imposed by secondary authorities, such as the Federal Housing Administration (for FHA loans), or Freddie Mac and Fannie Mae (for conventional home loans).
These government and government-sponsored organizations impose underwriting guidelines on lenders. For example, if a mortgage company wants to sell its loans to Freddie Mac or Fannie Mae, those loans will have to meet certain pre-established criteria.
The same is true for FHA loans, only in this case it’s the Federal Housing Administration that determines the eligibility criteria.
Many of the guidelines from these secondary authorities require mortgage companies (and their underwriters) to obtain letters of explanation from borrowers. At least, in certain situations. This is how mortgage companies document things within the borrower’s file.
The LOE is basically a way for the lender to say: “Yes, we are aware of this issue. But we have looked into it and determined that the borrower is still a good candidate for a loan.”
Example: A mortgage company might ask for a letter of explanation relating to a negative entry on a borrower’s credit report. This requirement could come from the lender, or from secondary underwriting guidelines imposed by FHA or Freddie Mac. The end result is that the mortgage lender must request a letter of explanation to document the issue.
Common Underwriting Scenarios
There are probably dozens of reasons why a lender would ask for a letter of explanation from a borrower. Here are some of the most common situations that might “trigger” it:
- Large withdrawals from, or deposits into, the borrower’s bank account — particularly in those cases where the underwriter cannot identify the source or reason for the transaction.
- Negative entries on a credit report, such as missed payments, delinquencies, foreclosures, etc.
- A high level of debt in relation to the borrower’s income (i.e., a high debt-to-income ratio, or DTI).
- A banking fee, such as an overdraft fee, that suggests the borrower has had problems managing finances in the past.
- A gap in employment that left the borrower without income for a period of time.
None of these issues are necessarily deal-breakers by themselves. They’re just common scenarios where mortgage underwriters tend to request letters of explanation as part of the documentation process.
If the LOE fully explains the issue, and the borrower meets all other lender and secondary criteria for approval, then the loan can still move forward.
There aren’t any statistics in this area. But I would say that most of the cases where mortgage company asks for a letter of explanation end up with approval and funding. So again, the LOE by itself is not cause for panic.
LOE: Summary of Key Points
We’ve covered a lot in this tutorial. Here’s are the key takeaways:
- A letter of explanation (LOE) is a fairly common occurrence in the mortgage underwriting world, and they’re not always a bad thing.
- Lenders and underwriters sometimes ask for these letters in order to document something, to obtain more information, and to satisfy the requirements imposed by FHA, VA, Freddie Mac, etc.
- Common issues that can cause the underwriter to ask for a letter of explanation include: changes in employment and/or income, large bank deposits and withdrawals, late payments, credit report discrepancies, and extenuating circumstances that might support the borrower’s cause.
Note: This article explains what a letter of explanation is, and how to write one. This is a general tutorial that may not cover all mortgage scenarios. As a result, portions of it might not be relevant to your particular situation. When it doubt, ask your lender!
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author