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A letter of explanation gives you an opportunity to explain potential red flags in your credit history, which could help you land the home of your dreams even if you might otherwise be considered a less-than-ideal borrower.

For many of us, our home is the largest single purchase we’ll ever make—and perhaps the largest loan we’ll ever take out, too. It makes sense that lenders want to make sure you’re good for the money when they’re dishing out hundreds of thousands of dollars in cash.

That’s why you may be asked to write a letter of explanation as part of the underwriting stage of your mortgage application.

Just What Is a Letter of Explanation?

If you have questionable items on your credit report, a letter of explanation may be requested by your underwriter—the person at the mortgage company in charge of gathering and verifying your materials to make sure you’re a good candidate to apply for a home loan.

As with other types of loans and lines of credit, qualifying for a mortgage comes down, in large part, to creditworthiness: a borrower’s credit score, history of paying loans on time, maintenance of a low credit utilization ratio, and overall history of money management.

As part of the homebuying process, the underwriter will pull your credit report and look into all these details, and if they come across any red flags, they may ask you for a letter of explanation.

Situations When You Might Need a Letter of Explanation

There are a variety of situations in which you might be asked to provide a letter of explanation, and they’re not all specifically about your credit report—though many of them are. The underwriter may request a letter of explanation if:

• Your credit history shows late payments, accounts in collections, judgments, or other detracting factors

• There’s a discrepancy between the demographic information, such as your name and home address, on your credit report and the information you’ve provided in your mortgage application

• You’ve been living rent-free—in which case you’ll need a letter of explanation from the owner of the home, not one you’ve written yourself

• You’ve experienced big swings in income

• You’re applying for a mortgage solo but hold a joint bank account

• You have long gaps in your employment history

Basically, a letter of explanation might be requested any time something in your file needs … well, extra explanation.

4 Tips for an Effective Letter of Explanation

Although being asked to write a letter of explanation may sound like being assigned homework, it’s actually a great opportunity: It means you might be able to qualify for the loan you want even with an imperfect application.

Since the stakes are so high, you probably want to write the best letter of explanation possible. Here are some tips to help ensure you get an A+ on this particularly important homework assignment.

1. Keep It Simple

When you’re asked to explain yourself, it can be easy to jump into a broad-reaching narrative starting from childhood, but the best letters of recommendation tend to be short and simple: They clarify the situation being asked about and reassure the lender that the “red flag” situation won’t affect the borrower’s ability to repay the loan.

If you’re feeling stuck, you might try a mortgage letter of explanation template to help get the ball rolling. Here’s a fairly standard version:

Date

Lender
Lender’s Address
Lender’s Phone Number

Subject Line (RE: John Doe’s Mortgage Application)

Letter of explanation, naming the specific item being asked about and explaining it to the best of your abilities.

Sincerely,

Applicant’s Name
Applicant’s Address
Applicant’s Phone Number

2. Provide Clear Details

Generally speaking, you’ll want to specifically name whatever item you’re being asked about (late payments on a credit card account ending in 0101; an employment gap between 2/20/2020 and 9/07/2020; etc.).

Then explain. For instance, if you’re being asked about an employment gap, you might let the lender know that you were let go as a result of corporate downsizing and that you freelanced while searching for a new job.

If you’re being asked about late credit card payments, you might let the lender know that you were in the hospital at that time and thus unable to make your credit card payments, or whatever the case may be.

The key is to take responsibility for the issue and provide clear, pertinent details without being too wordy.

3. Be Honest

This may go without saying, but you definitely don’t want to lie in your letter of explanation. For one thing, doing so is likely to keep you from being approved for the mortgage—and for another, it can be considered mortgage fraud, a serious crime that can come with prison time and fines.

4. Acknowledge Responsibility, but Don’t Get Emotional

When writing a letter of explanation, you may be justifying negative items in your credit history that resulted from poor decisions—or just poor circumstances. Nobody’s perfect, but a lender simply wants to make sure you won’t default on your loan.

So it can be helpful to acknowledge the ways you’ve adjusted your financial habits in response to a negative item and to reassure the lender that it won’t have an impact on your ability to pay your mortgage.

For example, if you’re writing a letter of explanation to address late rent payments after a layoff, you might add that you’ve since saved up an emergency fund of three months of living expenses in order to avoid being financially blindsided in the future.

However, writing an emotional sob story won’t help. Remember: It’s a good idea to keep it simple, clear, honest and as short as possible while still covering all those bases.

The Takeaway

You may be asked to write a letter of explanation as part of your mortgage application process. The letter offers you a chance to explain any discrepancies or red flags on your credit report or other application materials.

Letters of explanation are a small part of the larger homebuying process—and SoFi is there for you every step of the way, from mortgage preapproval to move-in day.

SoFi offers home mortgage loans with competitive, fixed interest rates and terms ranging from 10 to 30 years.

Ready to see if a SoFi home loan could unlock the door to your dream house? It’s quick and easy to find your rate.

Photo credit: iStock/monkeybusinessimages

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Currency-hedged ETFs are exchange-traded funds created to minimize the risks of fluctuating exchange rates in ETFs that have foreign holdings.

Many investment companies offer two versions of the same ETF with one version including a currency hedge. The latter ETF has the same holdings as the former, but it also includes derivatives purchased to protect–or hedge–against currency risk. The protections come at a cost, however, and hedged ETFs may have higher fees than non-hedged ETFs.

Recommended: ETF Trading 101: How Exchange Traded Funds Work

Why Do Investors Use Currency-Hedged ETFs?

Since currency values fluctuate, exchange rates can affect the total return on an asset. While ETFs provide investors with a significant diversification, they don’t offer any protection against the investment risk created by foreign exchange rates. So purchasing an ETF focused on overseas markets creates an additional layer of volatility within the investment.

Currency shifts can boost or diminish returns on international investments — but they almost always make them more uncertain. If the local currency loses value against the ETF’s currency (in this case the dollar), that can offset returns for the dollar-based investor, even if the assets that make up the security’s returns go up in their own currency.

Since many ETF investors are not interested in forex trading, they can minimize their currency risk by purchasing a currency-hedged ETF, which can smooth out volatility related to foreign exchange rates.

Currency-hedged ETFs may have a slightly higher expense ratio than non-hedged ETFs, due to the cost of the futures contracts as well as potential expenses associated with the tools and people who develop the hedged currency strategy.

Recommended: How to Invest in International Stocks

How Do Exchange Rates Impact Investment Returns?

While a strong dollar may be good when you’re buying assets in a foreign currency, it can hurt returns on assets denominated in a foreign currency. Over the past decade, the strong dollar has meant that hedged portfolios tend to outperform those that weren’t hedged.

Here’s an example: If the dollar-to-foreign-currency conversion rate is 1 to 2, as in one dollar buys you two units of the foreign currency, and you buy 100 shares of a stock at 5 foreign currency units per share, it will cost you $250, or 500 foreign currency units. Now, let’s say those shares double, so that 100 shares are worth 1,000 foreign currency units instead of 500 and your investment is now worth $500, compared to the $250 you spent initially.

But if the dollar strengthened so that the conversion rate went from 2 foreign currency units per dollar to 4 foreign currency units per dollar, those 100 shares are still worth 1,000 foreign currency units but for a US investor, their $250 investment would have shown no gain. While this is an extreme currency fluctuation, it illustrates the reason that some investors might purchase currency-hedged ETFs.

How Does Currency Hedging Work?

Investors use two methods to hedge against currency risk: static hedging and dynamic hedging.

Static Hedging

Static hedging is the most basic kind of hedging. An ETF that uses static hedging has one strategy that it executes, regardless of market conditions. An ETF using this strategy would buy contracts in the future market that lock in a currency’s value relative to the dollar or set parameters around it.

The contract is an agreement to buy a currency at a future price, which has the same effect of cancelling out currency gains or losses if they move from the currency’s current value against the dollar.

Dynamic Hedging

Dynamic hedging may incorporate multiple strategies or change strategies as market conditions change. Dynamic hedging is not always in effect, instead the hedge is “put on” based on the judgment of the ETF manager. Sometimes this judgment reflects an algorithm or series of rules that looks at market conditions for determining when to buy and sell financial instruments that hedge currency exposure.

For example, an ETF might have a rules-based system that looks at the trend of a currency’s value against the dollar, the interest rates in both countries, and the overall value of that currency (namely if it’s more expensive than the dollar). Those data points and, specifically, how they change over time, would determine whether and how much to hedge the ETF at any given time

The Takeaway

Currency-hedged ETFs are one way to get exposure to foreign markets and protection against the currency risks that come with that type of investment, but they may cost more than non-hedged ETFs. It’s important for investors to understand how they work, as they start to build their own investment strategy and learn how to pick ETFs to include (if any) in their portfolio.

If you’re ready to start putting that strategy into action, a great place to start is the SoFi Invest investing platform, which offers personalized investment advice, a range of ETFs, and automated investing.

Start investing today.

Photo credit: iStock/Delmaine Donson

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SoFi Invest®

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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