When a borrower is trying to get a loan for a house, one of the things they'll need to do is fill out a lot of paperwork. In many cases that paperwork explains everything the lender and their underwriter needs to know. But in some cases that's not true, and a letter of explanation is needed. While that might seem daunting, or like there's a problem with the borrower's application, that's generally not true. Instead, these kinds of letters are becoming more common and are just used to clear up simple questions the underwriters may have about anything in the application they can't qualify or verify with the data they already have.
In other words, a letter of explanation is exactly what it sounds like. The lender and their underwriter are asking the borrower to explain something. That could be a change in jobs, a gap in employment, a large deposit into their bank account, a source of self-employed income, or just about anything else. These kinds of letters are also typically asked for if the borrower is purchasing a house a long distance from where they currently live. Are they moving? Did they change jobs? Will they telecommute? There are a number of questions the underwriter will seek to answer, but questions don't necessarily mean problems.
What the underwriter typically looks for is the borrower's ability to pay back the loan. As long as that can be verified to their satisfaction, the loan will likely be approved. They want the letter, or sometimes letters, of explanation in order to cover all of their bases and make sure that the information they are using to make an approval determination is as complete and thorough as possible. With that in mind, any borrower who's asked to provide a letter of explanation should do so quickly and efficiently, providing exactly the information the lender or the underwriter has requested from them.
If a borrower chooses not to provide a letter, refuses to do so, or otherwise doesn't give enough complete information to the lender when it is asked for, there is a possibility that the loan will be denied. In some cases the explanation itself will lead the lender or underwriter to deny the loan, but that's far less common. Most explanation letters are just used as a way to connect the dots, and when that's done the underwriter is satisfied with the information provided. Then they can move forward with underwriting and approving the loan, and the borrower can get the home they were hoping to buy.
If any borrower doesn't fully understand the questions being asked, they should get clarification before providing the letter. That way they can give the lender and the underwriter the information they need and want, so the loan can keep moving through the process. Failing to give them the information they want can actually result in the loan being delayed, and in some cases that could cost them the house they're trying to buy. It's always better to get that letter to the lender right away, so the loan can continue to be worked on by the underwriter and approval can be that much closer.
Overall, borrowers who are asked for letters of explanation shouldn't get worried about that type of request. They should simply make sure they understand the question, provide a direct and succinct answer, and then wait to see if the underwriter asks for anything else. There is no reason to assume that being asked for a letter of explanation means that the loan won't be approved. Many borrowers get nervous about these letters or see them as almost accusatory, but it's important to step back and treat these letters as what they really are. A lender's underwriter is asking a question, the borrower answers it, and the process of getting approved for the loan moves on.
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