Mortgage Underwriting Letter of Explanation: Sample and Overview

Reader question: “We have been asked to write a letter of explanation for our mortgage lender’s underwriter, regarding a bank overdraft fee. They were unable to provide a sample or template for a mortgage letter of explanation, but they did say to keep it simple. Why do mortgage lenders ask for letters of explanation, and do you have a sample template we can use to get started?”

The letter of explanation (or LOE for short) is a common part of the mortgage underwriting and documentation process. Some borrowers panic when an underwriter asks for such a letter, because they think the loan is going to be denied. But that’s not always true.

In fact, a request for an LOE is usually a good thing, because it means the underwriter is trying to document his way around a certain issue so he can clear the loan for funding.

Mortgage Letter of Explanation (LOE) Sample

Simplicity is key when writing a letter of explanation for a mortgage underwriter. All you really have to do is explain, in clear and simple language, what the lender wants to know.

For example:

  • If they’re inquiring about an overdraft fee, tell them why it happened and whatever extenuating circumstances might have been involved.
  • If they want an LOE to better understand a recent bank withdrawal, simply provide the details of that transaction and why it was necessary.

Here is a sample template for a mortgage letter of explanation:

June 1, 2017

To whom it may concern:

I am writing to explain a bank deposit for the amount of $6,800, which went into my checking account with Hometown Bank on May 2, 2017. I deposited funds received for the sale of my 2005 Honda Accord to John Doe on April 28, 2017. I have enclosed a receipt for the sale of the vehicle.

Sincerely,

Sally Smith (and spouse name if joint application)

When writing a mortgage letter of explanation, be as specific as possible and include actual dates and dollar amounts. If your LOE relates to a late payment or some other negative issue, you might want to describe the steps you’ve taken to ensure it won’t happen again.

Why Lenders Ask for Them

So, why do mortgage lenders ask for letters of explanation regarding certain financial issues? It usually has to do with credit and underwriting requirements that are imposed by secondary authorities, such as the Federal Housing Administration (for FHA loans), or Freddie Mac and Fannie Mae (for conventional home loans).

These government and government-sponsored organizations impose underwriting guidelines on lenders. For example, if a mortgage company wants to sell its loans to Freddie Mac or Fannie Mae, those loans have to meet certain criteria. The same is true for FHA loans, only in this case it’s the Federal Housing Administration that determines eligibility criteria.

Related: What do underwriters ask for?

Many of the guidelines from these secondary authorities require mortgage companies (and their underwriters) to obtain letters of explanation from borrowers. At least, in certain situations. This is how mortgage companies documents things within the borrower’s file.

For example: A mortgage company might ask for a letter of explanation relating to a negative entry on a borrower’s credit report. This requirement could come from the lender, or from secondary underwriting guidelines imposed by FHA or Freddie Mac. The end result is that the mortgage lender must request a letter of explanation to document the issue.

Common Underwriting Scenarios

Here are the most common situations that will “trigger” a mortgage letter of explanation:

  • Large withdrawals or deposits from a banking account, particularly those for which the underwriter cannot identify the source or reason.
  • Negative entries on a credit report, such as missed payments, delinquencies, foreclosures, etc.
  • A high level of debt in relation to the borrower’s income.
  • A banking fee, such as an overdraft fee, that suggests the borrower has had problems managing finances in the past.

None of these issues are necessarily deal-breakers by themselves. They’re just common scenarios where mortgage underwriters tend to request letters of explanation as part of the documentation process.

If the LOE fully explains the issue, and the borrower meets all other lender and secondary criteria for approval, then the loan can still move forward.

There aren’t any statistics in this area. But I would say that most of the cases where mortgage company asks for a letter of explanation end up with approval and funding. So again, the LOE by itself is not cause for panic.