When you apply for a mortgage, your lender may request a letter to check your credit score and credit history. Part of this financial background check includes credit inquiries and any gaps in employment history. A credit inquiry is when a lender checks your credit report to assess your creditworthiness with the prospect of lending you money. Too many different credit inquiries can imply you have applied for several loans. This could mean you have a high debt-to-income ratio.
Your mortgage lender will want you to clarify the cause and purpose of these credit inquiries, hence the need to write an explanation letter. A well-crafted credit inquiry letter of explanation can explain honestly and clearly your financial history and your real estate ownership and help your mortgage lender establish a clearer picture of your current finances.
What Is a Credit Inquiry Letter?
A credit inquiry happens when a creditor, financial institution, or lender asks to review your credit report from one of the major credit reporting agencies (like Experian, Equifax, or TransUnion). This is typically done to evaluate your creditworthiness when you make a loan application. They may request to know how much mortgage loan you already carry and how often you have applied for credit.
There are two main types of credit inquiries: soft inquiries and hard inquiries.
Soft Inquiries
Soft inquiries happen when a person or company checks your credit as part of a background check. This could be a credit card issuer checking if you qualify for certain credit card offers, or an employer doing a background check. Unlike hard inquiries, soft inquiries don’t affect your credit score, as they are not connected with an active search for new credit on your part.
Hard inquiries
Hard inquiries occur when you apply for a loan, mortgage, credit card, or any other form of credit, and you have authorized the lender to check your credit. The report records all the lenders or creditors you’re interested in establishing credit with, as well as those who have looked at your credit report. These inquiries are a good indicator of credit risk.
Hard inquiries can slightly lower your credit score for a short period. This happens because applying for new credit can imply a higher risk, especially if several inquiries are made over a short period. For instance, if you’re applying for multiple credit cards at once, it might appear to lenders that you’re in a financially unstable position.
A single hard inquiry might only slightly affect your credit score but multiple hard inquiries in a short period can have a more significant impact. Lenders and creditors might interpret this as a sign of financial distress, potentially making it more difficult to obtain credit. They will wonder why you need so many credit lines and whether you are facing financial hardship.
However, certain types of credit checks, such as those for auto or mortgage loans, are often treated as a single inquiry if they occur within a specific timeframe. This is because it’s understood that consumers are likely shopping around for the best rates. The explanation letter is meant to explain this and show that you are a creditworthy person.
The Purpose of the Letter of Explanation
You may be asked to write and provide a letter to explain the recent inquiries on your credit report for up to 120 days.
Letters of explanation for credit inquiries serve to clarify the reason behind each inquiry on your report. They reassure the lender of your ability to repay and that you are a responsible borrower. The goal of writing a letter is to provide a clear and honest explanation for each inquiry, dispelling any concerns about financial instability or excessive credit-seeking.
It can take up to 60 days for an account to report your credit, so an inquiry could signal another account with another payment. Your mortgage lender wants to be sure about the total amount of debt you carry and how much more debt you can safely include in your expenses.
You will have to let them know if you established new credit with the inquiry or not. If you did, you will have to provide your most recent statement showing how much credit limit you were granted, the interest rate, and what the monthly payment will be. The underwriter may use this information to update your debt-to-income ratios (DTI). If you did not establish credit with any of the inquiries, you will have to state that in the credit inquiry letter of explanation.
How to Write the Letter
Start with your personal information
Begin your letter by writing your full legal name, address, and date. Address the letter directly to the lender or the person who requested it. Additional information you could provide is your mailing address and phone number.
Be clear and concise
Directly reference the credit report in question, and list the inquiries that have been made. For each inquiry, provide a brief and straightforward explanation. For example, if an inquiry was made for a car loan or to buy a home, state this clearly.
Provide relevant documentation
To support your case, provide the relevant documentation. Paperwork, forms, and applications as well as proof of opened credit lines, such as opening a new credit account, should be supplied to your creditors so they can have a clear picture of your financial situation and overall debt-to-income ratio.
Honesty is key
We can’t stress enough the importance of being honest in your explanations. If you were shopping around for the best loan rates, say so. When buying a house you need to find the financial support that best suits you. The lender will appreciate the honesty and it can often work in your favor. Remember that your lender will find out the truth anyway, therefore being honest from the beginning will support your case.
Professional format
Keep the tone formal and respectful. This letter is a professional document and should be treated as such. Keep your letter of explanation simple and to the point. Your lender simply wants to know the reason behind any recent credit inquiries.
Proofread process
Before sending the letter, check for any spelling or grammar mistakes. A well-written, error-free letter presents you as a more credible and responsible individual.
Sign your letter of explanation
Don’t forget to sign and date your letter of explanation or the underwriter may reject it.
Letter of Explanation for Credit Inquiries for Society Mortgage
Your mortgage application may require you to supply a letter of explanation for credit inquiries. This letter is meant to explain to the underwriter what the inquiries were for and whether you have a new line of credit that hasn’t shown up on your credit report.
Provide any information such as late payments or business tax returns you may have forgotten to mention. Be honest, be open, and be clear and your letter of explanation will support your case with your lender.
If you need help with your letter of explanation, talk to a mortgage loan officer today and let them help you with your mortgage application!
