Explaining the “Letter of Explanation”

It’s not unusual these days to have a lender request a “letter of explanation” from a home buyer or someone who is refinancing their current property.  I letter of explanation (or LOE) is often used to help provide more information to the underwriter or lender based on information that is disclosed on an application or credit report. LOE’s may address anything from gaps in employment to inquires on a credit report and is intended to help explain or add support to the transaction. If a borrower has had an extenuating circumstance and is trying to have an exception made to an underwriting guideline, they may be asked to write a LOE.

When a borrower is asked to write a letter of explanation, they need to address what the situation was, why it happened and possibly, what has been done to improve the situation.  For example, if someone was unemployed for a while or had their income reduced. If you’ve had your credit checked in the last 120 days, be prepared to provide an LOE addressing each inquiry. The lender needs to know what the inquiry was for and if a new debt was incurred from each inquiry.

Sometimes lenders will require a letter to explain one’s motivation for buying. This may sound silly to you, this is because of past cases of fraud, typically those involving occupancy. This request may be triggered when someone buys a smaller home than what they currently own as owner occupied or buying another home that is nearby (within 50 miles) of their current residence that they own. These circumstances can raise a red flag to an underwriter and if the property and transaction appear to be more fitting as an investment property than a primary residence, the underwriter may still want to treat the transaction as an investment regardless of how strong the letter is.

When you write a letter of explanation, consider that you are essentially writing this to the underwriter and your goal is to present a good case of why you should be approved for a mortgage. Be truthful, thoughtful, keep to the point and if you have any documents that may support your scenario, you may want to include it.  Letters of explanation are not an uncommon request in today’s mortgage climate.

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