Why do mortgage lenders need a letter of explanation?


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If you’re in the process of buying a home, you’ve probably already figured out that applying for a mortgage can be a lengthy process requiring a ton of paperwork.

At some point in that process, your mortgage underwriter may have asked you to provide a letter of explanation. If this is the first time you’ve been asked for a letter of explanation—sometimes called an LOX among real estate professionals—you might be confused about what you’re supposed to provide and why you’re being asked for it.

What is a letter of explanation?

Underwriters take a close look at your finances when they decide whether to offer you a mortgage. They’ll ask you to provide financial documents, such as tax returns and pay stubs, to get a complete picture of your financial situation.

If something raises a flag during the mortgage underwriter’s review of your application, you may be asked to provide a letter of explanation that clarifies the situation. You may also be asked to provide further documentation along with the letter.

Why do you need a letter of explanation?

Any number of situations may cause a mortgage underwriter to ask for a letter of explanation.

You may be asked for a letter of explanation if there are issues with your credit report. Sometimes these issues are relatively minor, such as an incorrect address or employer. (It’s a smart idea to request your credit report before applying for a mortgage; that way you can correct any such errors in advance, so you won’t have to explain them in a letter later on.) You may be asked to explain an overdraft charge or a bill that went into collections.

A mortgage underwriter may ask you to provide a letter of explanation if something in your bank account raises questions. For example, you may be asked to explain the circumstances if you recently deposited a large sum of money into your checking account. If your income or bank balance has radically changed in recent months, you may have to justify those circumstances, too. Sometimes an underwriter wants more information about previous places that you’ve lived, or your employment history.

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In short, a wide variety of circumstances can cause a mortgage underwriter to ask you for more information. If you’re asked to provide a letter of explanation, don’t panic—it’s a very common part of the mortgage application process.

How to write a letter of explanation

The letter is considered a piece of supplemental information that goes along with your mortgage application. With that in mind, make sure it is thorough and accurate. It’s best if you provide supplemental documentation along with your letter. For example, if you’re asked to explain a large deposit in your account, you can provide a letter noting that the money came from the sale of your car. Along with the letter, you should include the sales receipt or any other paperwork that supports your explanation.

Include specific information, such as dates and dollar amounts, whenever possible. If your letter of explanation concerns a missed payment or late bill, you can explain the circumstances that led to the problem, as well as any steps you may have taken to ensure you won’t run into similar issues in the future.

Like any other piece of official correspondence, your letter of explanation should be signed and dated.