When you apply for a mortgage, your lender will look at your complete financial picture to determine if you qualify to borrow money to buy a home. But sometimes, numbers alone don’t tell the whole story.
That’s where a mortgage letter of explanation comes in. Read on to see why a letter of explanation (LOE) may be necessary and what to include in one during the mortgage application process.
- Mortgage lenders look at factors that include your income and employment history to see if you qualify.
- If you’ve changed jobs or have an income or employment gap, it could hurt your chances of approval.
- A letter of explanation gives you a chance to explain your circumstances and show why you would still be a good mortgage candidate.
What Goes Into A Mortgage Application?
Since mortgage loans tend to be for large sums of money, lenders are very careful when reviewing applicants to ensure that they will be repaid.
When you apply for a mortgage, you can expect lenders to look at factors that include your:
- Credit score and history
- Debt-to-income ratio
- Income and employment history
Each of these factors tells lenders how much risk they may be taking on in the course of loaning you money.
Why Mortgage Lenders Care About Your Income And Employment History
Your mortgage lender has one goal when loaning you money: to get repaid. For this reason, you need to meet specific criteria to get approved.
Both your credit score and credit history tell lenders whether you tend to do a good job of repaying debts on time. The higher your credit score, the more likely you will be approved for a mortgage. However, there are other factors lenders consider when approving mortgage applications.
Your debt-to-income (DTI) ratio tells lenders how much debt you have relative to your income. The lower the ratio, the more confident a lender might be that you’ll be able to make your mortgage payments every month.
While your credit score and DTI ratio tell lenders how reliable a borrower you are and what your debt load looks like, to get a complete picture of your ability to repay a mortgage, lenders need to understand how much money you earn and how stable your job is.
You could have outstanding credit and very little debt. But if you don’t earn enough money to be able to cover your mortgage payments, a lender is unlikely to write you a loan.
Having enough income to cover your mortgage payments isn’t enough, however. Mortgage lenders also like to see stability and consistency when it comes to your income. They also tend to want reassurance that your income is ongoing. If you get a new job in a new field, a lender may worry about income stability (though a recent job change in the same field is usually acceptable).
Let’s say you currently earn $100,000 a year, which is enough money to cover your mortgage payments. If, up until a few months ago, you earned only $25,000 a year because you were in an internship or a stepping-stone role, a mortgage lender might be hesitant to give you a home loan without an explanation of the circumstances.
Similarly, if you’re self-employed and your income tends to fluctuate, a lender may be hesitant about issuing you a loan. If you end up having a period of lower income, you could be at risk of not being able to pay your mortgage.
Furthermore, if you’re new to your position or field, a mortgage lender might wonder how stable your job is. The same holds true if you have a notable employment gap. In that case, a lender might worry that you’re going to take another extended career break, compromising your ability to repay your mortgage.
What Is A Letter Of Explanation For Home Loans?
A mortgage letter of explanation is a document that clarifies a confusing or potentially problematic aspect of your mortgage application.
When a mortgage lender looks at your application, they don’t see the story behind the numbers. A letter of explanation gives you an opportunity to provide your lender with the context that helps strengthen your application despite a potential red flag on your application.
When You Might Need A Letter Of Explanation For A Home Loan
There are a number of reasons why you might need a letter of explanation in the course of applying for a mortgage.
If your credit score recently declined due to a temporary situation, like an illness or injury that forced you to take on debt or fall behind on bills, that’s something worth explaining to a lender. A mortgage lender might treat your situation differently from someone whose credit is poor due to a history of overspending.
Similarly, you might need a letter of explanation if any aspect of your employment history could raise a red flag. That could include:
- A very recent job change into a new field
- Multiple job changes within the past year or so
- A lengthy gap in employment
- A recent transition to self-employment
All of these situations might make a lender wonder how stable your employment is and whether you’ll be able to keep up with your mortgage payments.
In some cases, your mortgage lender will tell you whether or not you need to write a letter of explanation. But if you think there’s an aspect of your employment history that will raise a red flag, it could be a good idea to write one proactively.
Keep in mind that in many cases, starting a new job in the same field won’t trigger the need for a letter of explanation. It’s not uncommon to take a better-paying job in your industry when the opportunity arises or to take a comparable job at another company.
Even so, it may not hurt to provide a letter of explanation in that situation. You could explain that you’re simply pursuing a better opportunity in your field.
How To Write An Effective Letter Of Explanation
The purpose of a letter of explanation is to clarify any situation that might make a mortgage lender nervous to loan you money. The letter should be straightforward and include the details of your situation.
Let’s say you need to write a letter of explanation because you’re on your third job in 12 months. You might explain why your previous two roles weren’t a good fit and why you’re confident your current role is more stable.
Or, let’s say you recently went from being a salaried employee to a freelancer. You could explain in a letter that you have a number of clients and contracts lined up and you’re confident you’ll be able to bring in a comparable salary or higher than what you were previously earning.
If there’s a big gap in your work history, you can use a letter of explanation to discuss the reason – it may be that you took a few years off while your children were very young. If they’re now in school and you intend to work full-time for the foreseeable future, that’s valuable info to share with a mortgage lender.
Or, it may be that you took a year off from work to care for an ailing family member. You can explain why that unemployment gap was lengthy but temporary.
Best Practices For Writing A Mortgage Letter Of Explanation
A letter of explanation could, in some cases, mean the difference between getting approved for a mortgage or not. Keep these elements in mind when writing your letter:
- Be honest. If you lie about your employment history or situation and get caught, it could ruin your chances of getting approved for a mortgage.
- Don’t tell your life story. Address the question at hand as it relates to your employment situation, but don’t share details that aren’t relevant. Keep your letter concise and to the point.
- Include supporting documentation if applicable. If you’ve recently become self-employed, it may help to include contracts that show you have steady work lined up. If you’re new to your job or field, consider including a letter from your employer confirming the stability of your current role.
- Proofread your letter carefully. The more polished your letter is, the more effective it might be.
Sample Letter Of Explanation
A letter of explanation should include the following details in the header.
- Date
- Lender’s name and address
- Your name
- Your mortgage application number
From there, simply dive into the details of your situation. For example, if you’ve only had a higher income for a few months, you could write:
“To whom it may concern,
I’m writing in reference to mortgage application number 63742. I want to explain why my income was $25,000 for two years and recently rose to $100,000.
For two years, I participated in a paid internship program that allowed me to learn the ins and outs of my industry. As part of the program, I received training that made me qualified for a higher-paying role, which the internship helped me secure.
I have now been at my current role for three months and am thriving. The company is stable, and I am a full-time employee on the company’s payroll with no plans to leave. My current salary is sufficient to make the mortgage payments for the loan I am applying for.
Thank you,
Bob Jones”
As a general best practice, keep your letter succinct while getting into just enough detail to get your point across.
The Bottom Line: Writing A Mortgage Letter Of Explanation Can Pay Off
A mortgage letter of explanation is your opportunity to provide details about an aspect of your job situation or history that might cause concern for your lender. It’s best to keep that letter detailed yet concise. It’s also essential to make sure your letter is accurate and truthful.
One thing you don’t want to do, though, is use a letter of explanation to misrepresent your situation to get approved for a mortgage. If you don’t have a steady job or income and you lie about it, you might get your mortgage – then fall behind on payments later. That’s not going to be helpful to you. So if your job situation is such that you’re not ready for a mortgage, it’s better to be honest with yourself and wait until your income stabilizes before trying to buy a home.
If you’re confident in your ability to pay a mortgage, however, a solid letter of explanation could help you get approved. Explore your loan options to find the best loan for your finances and needs.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
