How to write a mortgage cover letter
If your credit history has a negative history, or if there is something about your mortgage application that requires more …
If your credit report has a negative history, or there is something in your mortgage application that requires more information, a lender may ask you to submit a “letter of explanation.” It is not a cause for panic. You can view the letter request as an opportunity to clarify something the loan underwriter needs to resolve before approving your loan. Here’s what you need to know.
[Read: Best Mortgage Lenders.]
What is a letter of explanation?
A letter of explanation is your chance to answer any questions a lender may have about your loan application. This can range from a gap in your job, to a gift you received from your family, to a collection action on your credit report. It is designed to give underwriters, who are responsible for finalizing the loan, all the information they need while they analyze your application.
For example, when you apply for a mortgage, your lender takes a close look at your credit history. Specifically, lenders check for derogatory marks on your credit report, such as late payments, defaults, write-offs, bankruptcies, foreclosures, and judgments.
Subscribers are often required to obtain letters of explanation for certain application issues. There are guidelines set by the secondary organizations that support or purchase the loans, such as the US Department of Agriculture, the US Department of Veterans Affairs, the Federal Housing Administration, or Fannie Mae and Freddie Mac. You may also be asked to provide a letter of explanation when applying for jumbo loans, which have additional standards, and even some refinancings.
When a lender asks for a cover letter, you can take it as a good sign because you weren’t rejected out of hand. This gives you the opportunity to share additional details that might influence the approval. Everything about your loan application might look good except for this thing that you need to explain.
Situations that may require a letter of explanation
Lenders might ask for a letter of explanation if anything in your credit history or financial situation raises an eyebrow during underwriting. Jackie Windham, senior vice president of mortgages at SouthEast Bank in Tennessee, says a lender can request a letter for any of the following reasons:
– There are late payments, collection accounts, judgments or bankruptcies on your credit history.
– The name and address on your credit report does not match the name and address you provided in your mortgage application.
– There are discrepancies between the employment history you report to the mortgage lender and what is shown on your credit reports.
– You have an active fraud alert on your credit reports.
Unrelated to your credit reports, Windham says a lender may request a letter explaining issues with your bank account, such as unusually large overdrafts, deposits or withdrawals, or large transfers between accounts. Your lender may also ask you for an explanation if you have a joint account with someone else but are applying for a mortgage in your name only.
You should also be prepared to write a letter explaining any inconsistencies in your work history, such as prolonged periods of unemployment or a total work history of less than two years. And a lender may ask you to explain the big fluctuations in your income if your tax returns or pay stubs show significant ups and downs.
“The letter of explanation is the underwriter’s way of showing that an item needs further explanation,” says Windham.
[Read: Best FHA Loans.]
Example of a letter of explanation
If your lender asks for a letter of explanation, you’ll want to state what the problem is and, if necessary, describe how it was resolved. You won’t need to write a long letter, just stick to the facts. Windham provides a sample letter of explanation for an address discrepancy:
In response to the underwriter’s request, I send this letter to explain the differences in my address. I moved from my home to (enter address) and moved into an apartment while buying a house. Not knowing the exact length of time I would be living in an apartment, I changed my mailing address to my mom’s address at (enter address) so I could receive all mail.
Please let me know if there are any other questions.
Shashank Shekhar, CEO and Founder of Arcus Lending in San Jose, Calif., Says your letter should include all relevant information requested by the lender, presented in a way that gives a clear picture of your situation.
“Be honest, provide details that will help you prove your side of the story and get your loan approved,” he says. “For example, if you have had many job changes in the past, explain why you had to leave those jobs and how you are committed to keeping the current job for the long term. ”
Can you avoid having to write a letter of explanation?
Shekhar says you may be able to avoid having to write a letter of explanation by sharing any potentially problematic financial situations with your lender up front. While there is no guarantee that you will not need to provide a letter yet, you can give your loan officer a better idea of your repayment capacity if you are upfront about past credit errors. or financial problems.
In addition, there are things you may be able to do before applying for a mortgage that could reduce the chances that you will be required to submit a letter of explanation. Here are three strategies Windham recommends:
– Wait to apply for new credit within the 120 day window before applying for a mortgage. Asking for new credit cards or loans could give a lender the impression that you are strapped for cash.
– Avoid making an overdraft on your bank account within this same period of time. Overdrafts don’t show up on your credit report unless the overdraft goes to collections, but you don’t want lenders to assume you’re having trouble managing your bank accounts.
– Pay all your bills on time every month. Payment history is the biggest part of your FICO credit score, and late payments can be very damaging to your credit rating.
If you have bad debt collection accounts on your credit, you may wonder if it’s worth paying them off before applying for a home loan. The answer is, it depends.
Paying off a collection account won’t necessarily save you from writing a letter of explanation; the lender may still want to know why the account has become overdue. Collection accounts can stay on your credit report for up to seven years, even when they are paid off. But paying off a collection account tells lenders that you are ultimately honoring your financial commitments, even if you struggled to do so on time.
[Read: Best VA Loans.]
Could a lender reject your letter of explanation?
Shekhar and Windham both say yes, it is possible that a lender will review your cover letter and reject it. The main reason? The letter does not completely clarify the problem with your lender.
If this happens, write a new letter of explanation. You may want to go into more detail or support your letter with supporting documents.
For example, let’s say you defaulted on a personal loan because you got sick and couldn’t work for a few months. Sharing copies of your medical bills gives the lender some context as to why you have not been able to meet the loan. Or it could be that the medical bills themselves are unpaid, so sharing these documents can strengthen your mortgage record.
If a lender is still unwilling to give you a home loan after resubmitting your cover letter, you may consider applying to another lender. However, you will have to start the loan process again and you will likely have to come up with another letter of explanation.
Another option is to delay your housing search for the short term. You could then take the time to work on cleaning up any negative credit items. It will also create some distance between the time of your application and your previous credit problems.
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How to write a mortgage cover letter originally appeared on usnews.com
Update 3/15/21: This story was originally posted on an earlier date and has been updated with new information.