As part of the loan process, your borrower may be required to provide an explanation for derogatory credit such as late payments, bankruptcy, or judgments.
This is a very important step and may make the difference in the loan program and interest rate that your borrower is approved for.
While some borrowers are sophisticated enough to handle the task independently, others may require some help.
Rather than writing an explanation yourself, give the borrower some guidance on the proper format.
A good credit explanation should contain the following:
1. An acknowledgement of what happened. This demonstrates honesty and understanding of the necessity to repay the debt.
2. A reason why it happened. Don’t leave this to the underwriter’s assumption. Circumstances that are within the borrower’s control will be viewed differently from those that are not (i.e., loaning your bill money to a friend vs. being laid-off from a job).
3. A statement of what is different now. This part of the letter is essential. The lender needs to know what has changed in the borrower’s life that will reduce the likelihood that the proposed loan will not go into early default.
4. Finally, if supporting documentation is available, include it.
A few excuses that are NOT recommended:
Make sure that your borrower’s credit explanation letter corresponds with the credit report.
If there are five derogatory items, make certain that all five are addressed rather than just two or three.
If a single incident caused several derogatory items, be sure that your borrower’s letter states that (i.e., job loss, divorce, etc.).
Most importantly the incident and the reason for it should make sense.