USDA loans are geared toward people wishing to have their primary residence in rural or suburban areas. These types of USDA loans are backed by the US Department of Agriculture and come with favorable income requirements terms, competitive interest rates, and no down payment requirement. These mortgages aim to help low- to moderate-income families purchase homes in rural areas. USDA loan income limits — typically capping at 115% of the median income for the area — are set to ensure that assistance is provided to those who need financial support to purchase a home in an eligible rural community.
Not everyone can qualify for USDA-guaranteed loans, though. One key aspect of qualifying for a USDA loan, on top of the USDA income limit, is to meet certain credit score requirements. With specific credit requirements in place that prospective borrowers need to know about, let’s take a look at how you can meet these demands and apply for a USDA loan type.
What Is a USDA Loan?
A USDA loan, guaranteed by the United States Department of Agriculture, is a home loan that aims to make homeownership more accessible in designated rural development areas. Home buyers who love living away from city centers have the opportunity to buy a home and repay the loan on favorable terms. If your work or lifestyle can accommodate living in a rural area on the property eligibility map, then a USDA loan can offer an excellent solution to finance your home-buying process.
USDA home loans come with several advantages that make them an appealing choice, especially for first-time home buyers. A USDA loan usually requires no down payment and offers a competitive interest rate and flexible credit requirements. On the downside, the cash reserves for USDA closing costs range from 3% to 6% of the home’s purchase price.
Credit Score Requirements
While the USDA does not set a strict minimum credit score for its loans, lenders typically may need a credit score of at least 640. This threshold is considered a baseline for the automated underwriting system used by the USDA — a score of 640 or higher typically enables smoother processing and quicker approval.
To get a better idea of what credit scores really mean, conventional loan options typically require a credit score of 740. The credit score requirement for FHA loans is 580, so the USDA loan credit score requirement of 640 is on the lower end of the scale.
What’s the automated underwriting system?
The Automated Underwriting System (AUS) is a loan products-driven tool used by lenders to assess the eligibility of home loan applicants quickly and accurately. This system evaluates the borrower’s creditworthiness and the overall risk associated with the loan by analyzing a variety of factors and generating a recommendation.
For USDA loan products, the AUS employs the Guaranteed Underwriting System (GUS).
How does the AUS work?
The AUS automatically processes data entered by the mortgage loan lender, including the applicant’s credit report, household income, assets, and other relevant information.
The housing lender will input the applicant’s financial information, credit history, and other pertinent details into the system.
- The AUS analyzes this data using predefined algorithms and criteria set by the USDA.
- The system evaluates the loan risk by considering factors such as credit score, debt-to-income ratio, employment history, and repayment ability.
- Based on the analysis, the AUS generates a recommendation, which can be an “Accept,” “Refer,” or “Refer with Caution.”
AUS recommendations
The AUS provides three main types of recommendations:
Accept
An “accept” recommendation indicates that the applicant meets the USDA’s criteria for creditworthiness. Since the applicant’s financial profile aligns well with the USDA’s guidelines, the loan can proceed with streamlined processing.
Refer
A “refer” recommendation suggests that the application requires further review and manual underwriting. It may indicate that certain aspects of the applicant’s profile need closer scrutiny or additional documentation.
Refer with Caution
“Refer with Caution” suggests a higher level of risk. Hence, the application will undergo a more thorough manual underwriting process to determine if the loan can be approved with compensating factors or additional conditions.
Manual underwriting
If an application receives a “Refer” or “Refer with Caution” recommendation, it doesn’t mean the applicant is disqualified. For example, if you have a credit score of 620, the algorithm will flag your application as risky and the loan file will go through manual underwriting.
This involves a detailed review by an underwriter who will consider additional factors such as an explanation letter for credit issues or gaps in employment. They will also consider compensating factors like significant savings or a strong rental payment history.
Manual underwriting helps applicants with lower credit scores for USDA loan that may technically disqualify them from the automated underwriting system.
Can I Get a USDA Home Loan with a Low Credit Score?
If your USDA loan application has gone to manual underwriting because your credit score is too low, you can still improve your chances of getting the USDA mortgage if you can supply proof of compensating factors. Here are some factors to consider.
Stable employment history
You can demonstrate a consistent and stable employment history to improve USDA loan eligibility. USDA-approved lenders look favorably on applicants who have been employed at the same job or in the same industry for at least two years, as it indicates financial stability and reliability.
Low Debt-to-Income Ratio (DTI)
A lower DTI ratio shows that you have a manageable level of debt relative to your monthly income. Ideally, your DTI should be 41% or lower. If you want to help your case, pay down existing debts to reduce your DTI.
Significant savings or assets
Substantial savings or other liquid assets can demonstrate financial prudence and provide a safety net for lenders. This can include savings accounts, retirement funds, or other investments that can be easily accessed in case of financial need.
Strong rental payment history
Providing evidence of a solid rental payment history can show lenders that you are capable of making regular, on-time payments. This history can act as a substitute for a good credit score as it demonstrates financial responsibility.
Large down payment
Although USDA loans don’t typically require a down payment, you can make one to reduce the lender’s risk. This shows commitment and financial capability and makes you a more attractive borrower in the eyes of your lender.
A co-signer with good credit
If possible, having a co-signer with a strong credit profile can improve your chances of loan approval. The co-signer’s income and credit score can help balance out your lower credit score.
Building and Improving Your Credit
If your credit score is below the desired threshold, there are some steps you can take to improve it before applying for a USDA loan.
Review your credit report
Obtain a free copy of your credit report and check for errors or discrepancies. Dispute any inaccuracies with the credit bureaus.
Pay down debt
Reduce your overall debt to improve your debt-to-income ratio and boost your credit score.
Make timely payments
Make consistent management and timely payments on your credit cards, bills, or other direct loans. Paying bills on time shows financial responsibility and is one of the most effective ways to improve your credit score.
Avoid new debt
Don’t open new credit accounts such as a credit card, or make large purchases on credit before applying for a home mortgage. Credit utilization is a factor taken into consideration and a new debt can look unfavorably when your credit score is for review.
Choose Society Mortgage for Your Dream Home
Are you interested in the USDA loan program but wonder if your credit score is high enough for one? Contact us at Society Mortgage and an expert Loan Officer will help you understand everything about applying for a USDA loan. Call us today, learn more about our services, and let’s start your guaranteed loan process together!
Frequently Asked Questions (FAQs)
What is the minimum credit score required for a USDA loan?
There is no strict minimum credit score set by the USDA; however, most USDA lenders prefer a score of at least 640. Scores below 640 may still be considered but will require manual underwriting and additional documentation.
What are some compensating factors for a low credit score in a USDA loan application?
Even if you have a low credit score, you may still qualify for a USDA loan, as long as you are within the USDA income limits and can provide compensating factors. Compensating factors include a stable employment history, low debt-to-income ratio, significant savings or assets, strong rental payment history, a larger down payment, and having a co-signer with good credit.
How does manual underwriting work for USDA loans?
Manual underwriting involves a detailed review of your financial situation by an underwriter. This process considers additional factors beyond your credit score, such as employment stability, debt-to-income ratio, rental payment history, and overall financial health.
How can I check my credit report for errors?
You can obtain a free credit report copy from the three major credit bureaus (Experian, TransUnion, and Equifax) through AnnualCreditReport. Review your report for any errors or discrepancies and dispute any inaccuracies with the credit bureaus.
Can I qualify for a USDA loan with 500 credit score?
While not impossible to qualify for a USDA with a 500 credit score, it would require some pretty strong mitigating factors, such as a convincing explanation of the reasons behind the score plus a stable employment history, a low debt-to-income ratio, a strong rental payment history, a larger down payment, a co-signer with good credit, etc.
