When you apply for a loan or a line of credit, your application may receive a letter saying that there were delinquent credit issues and requesting a letter of explanation. This means that while you have debts that are overdue for payment, the loan officer is undecided about whether or not to approve your request for a loan or line of credit. They are therefore requesting information from the potential borrower about the late payments to help them make a decision.
A letter of explanation is simple to write but should contain certain information to make it more useful to the potential lender; precisely what this information is, depends on what you are being asked to explain as you write.
What are delinquent credit issues?
If you receive a letter from a potential lender or bank saying that you have delinquent credit issues or derogatory credit issues, then your credit report will have consumer finance accounts that are due repayments that have not been made. You can request a copy of your credit report for free from credit bureaus, which may enable you to find out which account has late payments if you are not already aware.
Missed payments have a strong negative impact on credit scores and should be avoided, or at least cleared in a timely manner.
Delinquent credit issues may also refer to accounts in collection or any time you have declared bankruptcy.
How can delinquent credit issues affect me?
If you have delinquent credit issues, you may find it harder to get a personal loan or to have a successful mortgage application. This is because failing to make regular payments on a loan is a huge red flag to a loan officer and is often taken as indicative of a likelihood to fail to make payments on future loans.
More generally, they also reduce your credit score, meaning you may get rejected from some loans automatically until you improve your credit score, making it very difficult to become a borrower with a reputable lender.
What should I put in a letter of explanation?
If your lender asked for a letter of explanation, then you are being asked for more information or supporting documents about a certain event or period of your life. Although a letter of explanation won’t make up for outright bad credit, it can be the deciding factor in borderline cases.
Some reasons you may be asked for a letter of explanation are:
- You may be asked for tax documents or tax returns to prove your income if you are self-employed.
- If you have recently started a new job, or there are gaps in your employment history, you may be asked for more information, details of unemployment benefits you have claimed, or a termination letter from your last job.
- If you have recently received a large deposit into your account, the lender may wish to know where you received the money from, and why.
- If you have records of missed or late payment in the past, but not more recently.
If you have received a request for a letter of explanation due to delinquent credit issues, then you are being asked about this last situation. It probably also means that your credit report is not bad, but indicates that there have been difficult patches that are giving the loan officer doubt about your ability to repay the loan. They are looking for an explanation of any unusual circumstances in this period.
It is always best to be honest when sending a letter of explanation and supply supporting evidence along with it. For example, it could be that you had a medical issue that increased your debt and made making payments difficult, in which case the loan provider will want to see evidence that you now have medical insurance.
If you can explain why this happened and lend evidence such as supporting financial documents, that it will not happen again, then your letter of explanation is likely to prove successful.
On top of this, you should make sure to include:
- The date of writing
- Your details
- A subject line that contains your name and your loan application number or mortgage application number
- An explanation of each item of derogatory credit, one at a time.
If you are still unsure, you can find a sample letter online, however, a lender may feel that you are not being honest if it is a letter of explanation that is almost identical to one they have read before. In general, it is better to seek guidance but to actually write the letter of explanation yourself.
What is a Credit Report
A credit report is a complete financial picture of your credit history. If your credit report is in good standing, you will find it easier to receive favorable terms on loans and will be approved for a higher credit limit and lower interest rates. They will find it easier to get a home loan, potentially with a lower deposit and a smoother approval process. A good credit score makes the borrower more attractive to lenders.
Credit reports are compiled by credit bureaus, who collate the information made available to them by banks and finance companies.
Can a credit check affect my credit rating?
There are two types of credit checks, ‘soft’ checks and ‘hard’ checks.
Soft checks cover you requesting a copy of your own credit report, companies that you already have a relationship with doing a standard review of your credit. These are not entered into your credit history.
Hard checks, on the other hand, are potential lender requests. These do show up on your credit history and can have a negative effect on your credit score as they could be a sign of other loans you have been rejected for and negative items can give a bank pause.
What is included in a credit report?
A credit report will contain various pieces of information that can be used to identify you, such as your social security number, date of birth, and address.
It will also have details of your credit accounts, accounts in collections, and any time you have declared bankruptcy.
It will also contain a record of some of the inquiries made about your credit history.
How does a credit report help me get a loan?
A good credit rating can help a borrower by proving to a lender that they are not at high risk of not repaying the loan. They highlight any missed payments to lenders, along with other areas of financial difficulty, and so not having these on the report means that a lender will see you as a safer option than someone who has, for example, declared bankruptcy.
How can I improve my credit report?
Good credit reports can help you make it through the mortgage application process, or get approval on a loan application. They make the borrower seem less risky and so improving your credit score is very useful for a number of reasons, especially if you are looking at mortgage applications or another home loan. Mortgage approval is not easy but a good credit score can help with this.
Luckily, there are several ways to raise your credit score.
Provide proof of a stable home address
Primarily, lenders are looking for stability and so not moving frequently and providing proof of address can greatly help with this as it implies you have not had issues paying rent or paying a mortgage in recent years. The easiest way to do this is to ensure you are signed onto the electoral roll, as this does not require being a homeowner, named on the mortgage, or living alone.
Build a positive credit history
While it may seem redundant to say to improve your credit score by building a positive credit history, it may not be immediately clear how to do this. Some tips are below.
Make repayments on time
Ensure you make all of your payments when they are due, whether this is your mortgage, monthly bills, or student debt.
Borrow less than your limit
If you have a credit card with a limit, borrowing significantly less than this limit, and paying it off each month, will build your score faster than borrowing up to the limit and paying it off each month. This may seem pointless and frustrating, but lenders see those who do not live paycheck to paycheck as safer options, and not approaching your limit implies this.
Don’t close old accounts
A long, mature financial history can help improve your score as well, and for this reason, it is better to keep old accounts open to show that you can manage multiple accounts without running into difficulty.
It may be possible to set up a small monthly payment on these accounts and pay them off monthly via direct debit. This keeps them open to add to your financial history but prevents them from causing you any major issues that you would have to explain by writing a letter of explanation.
Get a credit boost
If you have very little credit history, it is likely your credit rating is low despite not having any debt, which can be frustrating. A credit boost is a service offered where a credit bureau gains access to your bank account and can review your payment history. This helps things like savings, subscriptions, and utility bills to be applied to your credit score. These things document how you spend your income and therefore whether or not you are likely to miss a payment.
Get a credit builder card
Credit builder cards are generally available no matter your credit score. They have very low limits and very high-interest rates and so are not often advised, and can even make your credit score go down temporarily. However, if you keep spending on the card and paying it off in full every month, your credit score will improve and you can avoid the high-interest rates.
How can I get out of debt?
If you have a large amount of debt, getting out from under it can feel like a mammoth task. You can feel trapped by high-interest rates and fees for delinquent payments. But with a little planning, you can regain financial control.
Methods of saving money and paying down debt
First of all, when you look to start saving you should take stock of your finances. Review your income and your outgoings by looking at statements from your bank account. You can use this to make a budget and cut out unnecessary expenditures.
If you set yourself a weekly budget for food, travel, and any non-necessities, you can take this out in cash to ensure you don’t overspend. Paying for everything in notes and putting the change in a jar to deposit in your savings can help, and you can also set up a direct debit to a savings account immediately after you get paid. You can use the contents of your savings account to pay down your debt. Every single dollar amounts to a dollar you are not paying interest on.
You may find that it is possible to consolidate your debt if you have numerous accounts, by speaking directly with a loan officer. This should cut down on the amount of interest due each month and allow you to begin to pay down your debt.
If this is not possible, you should keep paying the interest on your loans, and then put every extra penny into paying off the loan with the highest interest rate. You must still at least pay the interest on each loan, however, or you’ll find yourself in more debt than you were at the start.
Once you have a plan and have taken back financial control, you should be able to cut your expenses down to a minimum, whether this is saving on your grocery bills by cutting waste and eating vegetarian, or by canceling expensive, unused subscriptions and reducing your other bills by comparing providers.
You can put these savings into an account or immediately use them to pay down your debt.
Gain more income
The other way to pay off more of your debt is to increase your income. You can do this by gaining a side hustle such as freelance writing or by upcycling free furniture and selling it on for profit. Some people even start their own business doing this.
If this is not an option for you, you can request a raise at work or look for a new job that pays better.
All of this extra income should go straight into paying off your debt, starting with the one with the highest interest rate.
If you are asked for an explanation letter, such a letter should be honest and provide a strong explanation for weak points in your credit history with evidence for why it won’t happen again, to help the loan officer to successfully find a reason to grant you a loan or mortgage.
Writing the letter of explanation may seem daunting, but the lender is already considering approval if they request a letter of explanation or other financial documents. Relax, and explain what they have asked to you to write about. This document will be added to other supporting documentation for loan or mortgage applications and can tip the balance towards approval.