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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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If you’ve been investing for a while now—maybe through your employer’s 401(k) or an IRA—and you’re ready to take a more hands-on approach, you’re in luck. A growing number of financial firms are making online trading more convenient and affordable with easy-to-use websites and apps—often with no minimum balance required and commission-free trades.

Some online brokerages even allow investors to buy partial shares of company stocks they might not have had access to in the past because of the cost. Thanks to innovations in financial technology, or fintech, you can now buy and sell stocks and other securities from the comfort of your own couch—or while you wait in line for a latte.

But before you start buying and selling stocks from your phone, you’ll want to have at least a basic knowledge of how the market works; how online brokers execute trades; and how to develop an investing process that fits your personality, plans for the future, and bank account.

Here are some things to consider:

What Is Stock Trading?

All investors take a calculated risk with their money, with the aim of making a profit. But whether you are an investor or a trader depends on how long you typically hold on to investments. Investors are generally looking to grow their savings over the long-term for future goals, stock traders typically try to capitalize on short-term price fluctuations. That can take more time, attention, and exposure to risk than many investors would prefer to commit.

Are You an Investor?

Investors may track what’s happening with the major indexes and the securities in their portfolio, and they might do research or seek advice about the best companies in which to invest. But they’re more likely to use a buy-and-hold strategy—purchasing and keeping stocks or other securities with the idea that these investments will continue to increase in value over years or even decades.

Or Are You a Trader?

Traders keep a close eye on the market throughout the day. They pay attention to current news, tips, and research, and buy and sell stocks frequently. An active trader might buy and sell stocks several times a month, with the goal of beating the market (or getting a better return than the market average). A “day trader,” on the other hand, might buy and sell the same stock in one day, hoping to turn a quick profit and then move on to the next opportunity.

Or Are You Both?

There’s no rule that says you can’t engage in both passive and active investing. You might use your tax-deferred IRA to save for the long haul, for example, but set aside some money to try your hand at trading stocks as well.

It’s up to you how hands-on or hands-off you want to be. But knowing your investment style can help you decide if you’re really up for trading stocks yourself (instead of leaving most of the work to someone else). It also could help you choose a financial firm with the services you require.

Which Type of Broker Suits Your Style?

Investors and traders have a lot of options when it comes to choosing a broker—from long-established financial firms to newer names that offer intuitive online trading platforms and often lower costs.

If you want more help, you might be willing to pay extra for a full-service brokerage with a physical office and an actual person who takes and executes client orders. Or you might decide to limit human interaction (which can get expensive) and instead choose automated investing, leaving the heavy lifting to a robo-advisor that uses computer algorithms to build and manage an investment portfolio.

But if you truly want to get into researching and picking your own stocks, and executing trades on your own schedule, an active investing account with an online brokerage might be the right call.

Many financial websites offer up-to-date reviews of online brokerages, so that can be a good place to start researching. Some factors to consider might include:

•  The broker’s commission fees (many sites now offer free trading)

•  Account minimums (some online brokers don’t require a minimum deposit)

•  Available products (in addition to stocks, you may want to look at exchange-traded funds (ETFs), mutual funds, and/or fractional shares of stock)

•  Educational features

•  Other perks

Of course, you’ll be looking for a company with a solid reputation and good customer service. You can use the BrokerCheck database offered by the Financial Industry Regulatory Authority (FINRA) to get information on the background and experience of financial brokers, advisors and firms.

Once you choose your brokerage, you can open an account whenever you’re ready. (You don’t have to start trading right away.) You’ll probably need to provide your Social Security number and your driver’s license number or other ID. If you’re funding your brokerage account with an electronic transfer from your bank account, you’ll also want to have that information on hand. The website may ask for other information as well, to assess your goals and risk tolerance.

Learning How to Trade Stocks

Once you’ve funded your brokerage account you can start buying stocks. But be prepared—those decisions can be daunting for a newbie. While opening an account is easy, actually getting started investing may be a bit harder.

If you’re not sure where to start, you may want to look at exchange-traded funds, which offer the diversification of mutual funds but trade continuously throughout the day like stocks. ETFs are typically less expensive than either mutual funds or stocks.

Another way to get into the market at a lower cost might be to invest in fractional shares, or pieces of single shares of stocks you might otherwise find too expensive. With SoFi Invest’s fractional shares program, for example, investors can build a portfolio with big-name companies. But instead of buying whole shares, buyers specify the dollar amount they want to spend on a company’s stock. Before you invest in whole or partial shares, you may want to use an online screener to narrow your choices to stocks that meet your specific requirements and do some technical and fundamental research on potential investments. For example, are you looking for companies within a certain size range, or market capitalization (micro, small, mid, or large)? Is there a range you want to stay within when it comes to the price-to-earnings ratio (P/E)?

Recommended: How Market Capitalization Impacts Stock Value

Most screeners offer several filters to choose from, so you can find stocks at the price you want, or in a designated industry, or within a certain level of volatility. There are several well-reviewed free screeners available that may suit your needs as a beginner, including Zacks, FINVIZ, Yahoo Finance, TD Ameritrade, and TC2000. Or you might decide to pay for a subscription service that offers more in-depth analysis.

Even if you use a screening tool, it can be useful to do your own stock research as well. There are plenty of online sites that can help you learn more about how to trade stocks and calculate stock values. And many brokerages, including SoFi, provide users with educational resources and newsletters.

In addition, the Securities and Exchange Commission (SEC) requires all public companies to file financial documents with data that could help you further assess a stock’s value. You can use the SEC’s Electronic Data Gathering, Analysis, and Retrieval system, EDGAR , to access that information.

How Do You Feel About Risk?

How much risk are you willing to take when trading stocks online?

If you’re OK with a white-knuckled, stomach-churning roller-coaster ride—and you’re willing to lose everything on an investment—you can throw caution to the wind. But if you’re hoping to make money without chronic anxiety, you’ll probably want to put some strategies in place to better manage your risk. That might include:

Knowing How Much You Can Afford to Lose

Do you have your financial bases covered (with an emergency fund, for example, and good insurance that will cover you if an unexpected health, home, or automobile expense pops up)? Are you current on your bills, and are you socking away some money for retirement? Even if you’re feeling pretty financially secure, you may want to set a clear limit on how much you’ll spend on any stocks that might expose you to more volatility and, therefore, a greater potential for loss.

Keeping Your Emotions in Check

Thanks to 24/7 access to market news, and instant reactions on social media, it can be tough to tune out distractions that can lead to knee-jerk trading moves. Greed is a tough emotion to ignore when a friend or co-worker shares a hot stock tip. And fear can easily get the better of you when you watch your favorite stock suddenly drop.

As you begin trading, you may consider a journal to document what you did and why you did it, and measure your performance against a benchmark index like the S&P 500. Reviewing those notes could help you analyze and improve how you react to changes in the market. (You’ll also want to keep good records so you can manage the tax consequences of any gains and losses in your brokerage account.)

Diversifying Your Portfolio

It’s one thing to occasionally take a small gamble on a trendy stock. It’s another to put all your money into just one stock (even a Blue Chip), or one sector, or one asset class. Keeping a balanced mix of investment types could help lower your risk—and make following your gut once in a while a little less gut-wrenching.

Again, this is where ETFs or fractional shares can come in handy. It also may be useful to work with an advisor to establish an appropriate asset allocation strategy and set up a plan that helps keep you on track as you make moves on your own.

Recommended: Differences in Speculation and Investing

What Type of Trade is Right for You?

When you’re ready to start using your broker’s website or app to buy and sell stocks, you’ll see there are a few different options for order types, which dictate how your trade goes through.

The type of order you use will likely vary from one situation to the next, depending on how many stocks you’re hoping to buy or sell, how liquid the stocks in question might be, or if the stock is currently under- or over-valued. And once you get more comfortable, you may want to add more strategies (such as options and futures) to your trading repertoire. So it’s a good idea to be well-versed in all the possibilities, their pros and cons, and how they might work in various scenarios.

The two most common orders are:

Market Orders

If you place a market order to buy, you’re saying you’ll purchase the stock “at market,” or at the current lowest asking price. If you place a market order to sell, you’re saying you’ll sell for whatever the highest bidding price is at that time. Because you aren’t holding out for a better price, brokers can generally fill market orders pretty quickly.

Limit Orders

If you place a limit order, you’re telling your broker in advance the price you want to get on the trade. If your broker can get the price you want (or better), they will execute the trade. But if no one is buying or selling at the price you’ve set, the trade won’t happen.

Ready to Get Started?

If you’re feeling overwhelmed, you may want to practice a bit using a free stock-trading simulator that could help you become more fluent in market terms and actions. But with your online brokerage account funded, you also could begin making small trades to get your feet wet and see how it feels.

The Takeaway

Once you begin trading stocks online, you’ll probably be able to gauge pretty quickly what works for you and what doesn’t, both financially and psychologically. Learning the basics of online trading can up your comfort level even before you get started, but executing some money-making trades will likely build your confidence. (Making some not-so-great trades could also help you finetune your process.)

With innovative trading tools like SoFi Invest® brokerage platform, you can start slowly. With SoFi Invest, you’ll have a variety of investment alternatives to choose from. And you can count on SoFi’s educational resources, real-time investing news, and advisors for help when you need it.

Learning how to trade stocks is exciting. Get started with a SoFI Invest account

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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

Stock Bits
Stock Bits is a brand name of the fractional trading program offered by SoFi Securities LLC. When making a fractional trade, you are granting SoFi Securities discretion to determine the time and price of the trade. Fractional trades will be executed in our next trading window, which may be several hours or days after placing an order. The execution price may be higher or lower than it was at the time the order was placed.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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