If your financial or employment history is less than perfect, an underwriter might ask for a letter of explanation. These letters are generally asked for in situations that the circumstances are outside of the normal guidelines that an underwriter uses. A few examples include a large gap in your employment history, a bad spot on your credit report or excessive deposits in your bank account. These situations are not all-inclusive, there are literally hundreds of reasons that an underwriter might ask for a letter explaining a certain situation; it all depends on the underwriter and your exact scenario.
The Purpose of the Letter of Explanation
The main purpose of the letter of explanation is to provide further insight into the issue. The underwriter is looking to see that the situation is in the past and has been resolved with no future consequences. This is especially true for an employment gap, a series of late payments or excessive inquiries on your credit report. The letter should show the underwriter that the situation is not ongoing and that it has no impact on your ability to obtain a mortgage now.
What to Include
There is no template that will work for every LOX (Letter of Explanation); every situation has its own requirements. The most important thing to do is listen to everything that the loan officer tells you that the letter must include. As you go over the requirements, make sure to be as detailed as possible, including necessary dates, dollar amounts and reasons, as requested. You should also include any pertinent attachments that are available. This could be a letter from your doctor or employer or a letter from the creditor that you made late payments to, stating that the account is now brought current.
LOX for Cash Out Refinances
It is very common for underwriters to ask for a letter of explanation when you are applying for a cash out refinance. This is strictly because the underwriter wants to know what you plan to do with the money that you take out of the equity of your home. The underwriter needs clarification, in writing, that you are not going to use the money to create more debt for yourself, therefore increasing your debt-to-income ratio. You should specifically state in the letter whether or not you plan to use the money as a down payment on an investment property or 2nd home.
LOX for Gifts
If you are purchasing a home and part of your down payment is in the form of a gift from a relative, a letter will be required. The letter will need to be from your relative and clearly state that the money is a gift and does not need to be repaid now nor in the future. This is another way for the underwriter to ensure that you are not incurring further debt after you close on your new home.
The Letter of Explanation is not meant to be a bad thing – it is simply to ensure that the mortgage that you are applying for has your best interests in mind. Today lenders are very keen on ensuring that your debt ratio is in line and that you will be able to afford the loan well into the future. An underwriter asking for an LOX is not a sign that the loan will not be approved; it is simply a sign that a little more clarification is needed in order to ensure that the loan is a good fit for you. Make sure that you are as honest and detailed as possible and your LOX will likely help your loan approval.Click to See the Latest Mortgage Rates»