Sometimes there can be hurdles during the mortgage application process. One that might catch some applicants off guard is the need to provide an LOE, better known as a “letter of explanation.”
At times this letter of explanation can make or break the deal.
Understanding what a letter of explanation is, and knowing when and how to effectively draft one, can significantly impact the success of your mortgage application. Essentially, it’s your opportunity to provide context to an underwriter about any circumstances that might raise questions during their review.
In this article, we’ll dive into the specifics of the underwriting process, outline why you might be asked for a letter of explanation, and provide guidance on how to write one.
The Underwriting Process
The underwriting process is a crucial stage when obtaining a DSCR loan. During this phase lenders assess the risk associated with lending money to a prospective investor. While underwriters are typically scrutinizing the cash flow of the selected property, an underwriter can also scrutinize your financial history, including your credit score, income, debts, and assets. This detailed evaluation ensures that lenders approve loans that align with their risk tolerance levels.
During underwriting, every piece of financial information provided is verified, and any discrepancies or unusual activities are flagged for further investigation. It’s at this juncture that the need for a letter of explanation often arises. The goal of underwriting is to protect the lender’s interests.
Given its significance, the underwriting process can be thorough and sometimes invasive, requiring applicants to be transparent and cooperative. The better prepared you are to provide comprehensive and accurate information, including any necessary letters of explanation, the smoother the process will be.
Understanding that this scrutiny is part of safeguarding the financial system can help you approach the underwriting process with patience and readiness to provide clarifications as needed.
What is a Letter of Explanation?
A Letter of Explanation is a personal statement written by a mortgage applicant, addressing any concerns or questions an underwriter may have about their mortgage application.
This letter serves as a tool to explain circumstances that may raise red flags during the underwriting process, such as credit inquiries, excessive rehab costs, or significant unexplained bank deposits. Its purpose is to provide context and clarification, helping the underwriter understand the circumstances of interest.
This document is your opportunity to directly communicate with the underwriter, offering explanations or additional information that can aid in their decision-making process. A well-written Letter of Explanation can be pivotal, transforming potential obstacles into understood aspects of your financial history. It’s a chance to explain any financial challenges, demonstrate your stability and reliability as a borrower, and reassure the lender of your commitment to repaying the loan.
Crafting a Letter of Explanation requires a balance between being concise and providing sufficient detail. It’s important to directly address the underwriter’s concerns, offer clear explanations, and, where possible, include any supporting documentation. This proactive approach can significantly expedite the underwriting process by reducing back-and-forth communication and demonstrating your responsiveness and thoroughness as an applicant.
Why and When Would I Need to Provide a Letter of Explanation?
Common scenarios that might prompt the need for a Letter of Explanation during a mortgage transaction are circumstances that could impact your perceived financial stability or risk profile.
For instance, consider a borrower seeking a cash-out refinance on a property. If the underwriter notices that the rehabilitation costs for the property were twice what the borrower initially paid for the home, this could raise concerns. The lender might worry about the structural integrity of the property, the borrower’s financial management, or the potential overextension of their financial resources.
In such cases, a Letter of Explanation (LOE) becomes crucial. It allows the borrower to provide context and justify the financial decisions made regarding the property. The borrower could explain that the property was initially purchased under market value due to it being a distress sale. Then, detail the scope of the rehabilitation work to justify the costs, and illustrate how these improvements have significantly increased the property’s market value, leading to increased equity.
Common Triggers for a Letter of Explanation:
- Credit Inquiries: Clarifying recent inquiries on your credit report, especially if they could imply new debt obligations.
- Large Deposits: Detailing the source of large, non-payroll deposits into your bank accounts to prove they aren’t undisclosed loans.
- Differing Addresses: Addressing discrepancies in your reported living addresses, which might suggest instability or misreporting.
- Bankruptcy: Explaining the circumstances that led to a bankruptcy filing, what you’ve learned from the experience, and how you’ve improved your financial situation since then.
- Late Payments: Justifying any late payments on loans or credit cards, including the reasons for the delays and the steps taken to ensure timely payments in the future.
Providing a Letter of Explanation (LOE) for any of these scenarios enables you to proactively address potential underwriter concerns. By offering a clear, straightforward explanation you help the underwriter complete their evaluation more efficiently and favorably.
How to Write a Letter of Explanation for a Mortgage
Writing an effective Letter of Explanation for a mortgage underwriter involves clearly and concisely addressing the specific concern raised. You should provide relevant details, and, if applicable, explain what steps have been taken to mitigate such concerns in the future.
Let’s revisit the example of a borrower seeking a cash-out refinance. The lender is concerned about the rehab costs being twice the purchase price of the home. Let’s draft a response to the underwriter.
Letter of Explanation Template:
[Your Name]
[Your Address]
[City, State, ZIP]
[Date]
[Lender’s Name]
[Lender’s Address]
[City, State, ZIP]
Dear [Lender’s or Underwriter’s Name],
I am writing to provide clarification regarding the concerns raised about the rehabilitation costs of my property located at [Property Address], which are noted to be significantly higher than the purchase price. I understand that this may raise questions about the property’s initial valuation and my financial management, and I appreciate the opportunity to offer more context.
The property was acquired at a substantially lower market value due to it being a distress sale. At the time of purchase, the property required extensive renovations to make it habitable. The comprehensive rehabilitation included [briefly list major renovations such as structural repairs, electrical and plumbing overhaul, roof replacement, etc.], which were necessary to ensure the property’s safety and livability.
These improvements have not only enhanced the property’s value significantly but have also aligned its valuation with comparable properties in the area. Enclosed, please find detailed receipts of the rehabilitation work, along with before and after photos of the property.
I trust this letter clarifies the situation and demonstrates the prudent management of the property’s rehabilitation. I am committed to maintaining a strong financial standing and ensuring the success of this investment. Should you require any additional information or documentation, please do not hesitate to contact me.
Thank you for your consideration.
Sincerely,
[Your Signature (if sending by mail)]
[Your Printed Name]
Enclosures: [List of documents you’re including, e.g., receipts, photos]
Tips for Writing Your Letter:
- Be Specific: Address the underwriter’s concerns directly, providing specific details and explanations.
- Be Honest: Offer a truthful account of circumstances, including any mistakes made and learned from.
- Be Concise: Keep your letter to the point, avoiding unnecessary details that don’t contribute to your explanation.
- Provide Evidence: Whenever possible, include documentation to support your explanation, adding credibility to your statements.
By following these guidelines and using the template above as a starting point, you can craft a compelling Letter of Explanation that addresses the underwriter’s concerns.
Frequently Asked Questions
When faced with the task of writing a Letter of Explanation for a mortgage, many applicants have questions about how to approach this request effectively. Here are answers to some of the most commonly asked questions related to crafting a Mortgage Letter of Explanation.
The Wrap-Up
Navigating the request for a Letter of Explanation as part of your mortgage application doesn’t have to be a daunting task. By understanding the purpose of this letter, when it might be required, and how to structure your response, you can effectively communicate with your lender.
Key Takeaways:
- A Letter of Explanation helps clarify aspects of your financial history to the underwriter, improving your chances of mortgage approval.
- Being honest, specific, and concise in your explanation is crucial.
- Including relevant documentation can support your explanation and expedite the review process.
- Maintaining a professional tone demonstrates your seriousness and respect for the process.
By carefully crafting your Letter of Explanation, you provide the underwriter with the necessary context to better understand your situation. Remember, this letter is an opportunity to present your case clearly and positively influence the outcome of your application.
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