What is a Credit Explanation Letter & What Do When I Get One | Sample & Template

 When and Why You Need a Credit Explanation Letter

When applying for a loan, your lender checks your credit history for negative or derogatory signs like bankruptcy, foreclosures, late payments, among other factors. The lender might ask for a letter of explanation. 

The process may appear difficult, but you need to look at it as an opportunity to pass clear information, which might help you get the loan. 

Why Lenders ask for a letter of explanation

Several lenders ask for your credit explanation letter before approving your loan. Below are some of the most common reasons. 

Problems with Your Credit Report 

One of the main reasons that lead to your loan qualification is the ability to manage finances. However, if you're not capable of managing finances with signs of missed payments, defaulted loans, and foreclosures, your lender might question your credit history and will ask for a letter of explanation. 

The letter of explanation example will give reasons for the negative items on your credit history. You need to give the date, your account, and the creditor's name in the letter. Your lender wants to ensure that you can repay the loan with no difficulties. 

Change in Income 

A letter of explanation template explains why you had changes in your income. If there is a drop in your income, your lender can decide to decline the loan unless you explain. 

If you have a valid reason, such as career changes or employer change with better growth opportunities, your lender may see your reasons as valid and approve the loan. A letter might clear any concerns without which the lender wouldn't want to take high risks of a payment default. 

No Rent Payment 

Most lenders want to see a rent and mortgage history, which is a sign that you can pay your housing expenses on time. Maybe, you live with your parents or a friend. In this case, the person you live with will need to give your lender a credit explanation letter. 

The letter needs to show the length of time you've been leaving with the person and state that you stay rent-free. The letter needs to have a date and a signature. 

Changes in Your Employment 

There could be reasons you left a particular job recently or the large gap in your employment history. You might have missed some financial obligations during this time, which is a red sign to the lender. Lenders expect to see a consistent employment history. 

The most concern comes when you change jobs or careers frequently. The lender might consider it as job-hopping and would want a letter of explanation template for your actions. They want to know your reasons for changing jobs. Your answer will guide the lender if you're the right candidate for the loan. 

The Bottom Line

It's within the lender's interest to ensure no risks involved in approving the loan. Meaning, you need to be financially capable of repaying the money within the expected time. Once a lender sees any red flag in any of the above areas, they're likely to ask for a letter of explanation example with detailed information giving reasons to all the concerns. The letter makes the process easier both for you and the lender, increasing your borrowing power.