There aren’t many home buyers out there that have the money on hand to buy a house outright, which is why the majority of them turn to home mortgages. However, lenders typically require borrowers to have above a certain credit score to mitigate the risk of the borrower defaulting. This doesn’t necessarily mean that if you have poor credit that you’re out of luck. There are still some loan options out there that you might be eligible for despite your poor credit, such as the USDA loan.
Buying a home is an exciting milestone. But it can be really challenging when you have less-than-perfect credit. Fortunately, USDA mortgage loans may offer a path to homeownership even if you have bad credit.
In this article, we’ll explain what USDA loans are, who they are for, and how you can qualify for one with bad credit We’ll also provide tips for finding the best USDA lender and improving your chances of approval
What Are USDA Loans?
USDA loans are government-backed mortgages aimed at helping rural and suburban homebuyers with low-to-moderate incomes. The U.S. Department of Agriculture partners with private lenders to issue these loans.
There are a few key benefits that make USDA loans a great option:
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No Down Payment Required. Unlike most mortgages, USDA loans don’t require any down payment. This makes them more accessible for buyers with limited savings.
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Looser Credit Requirements. USDA loans are available to buyers with credit scores as low as 580. Many conventional loans require higher scores of 640 or more.
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Low Interest Rates. Interest rates on USDA loans are very competitive, given the small upfront costs. This makes them affordable even on a tight budget.
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No Mortgage Insurance. USDA loans don’t require private mortgage insurance (PMI) payments. Instead, a small upfront guarantee fee provides a similar safeguard for the lender.
Clearly, USDA loans open doors for buyers who may not qualify through traditional lending avenues. Keep reading to learn more about eligibility and how to get approved, even with bad credit.
USDA Loan Eligibility and Requirements
To qualify for a USDA home loan, you must meet criteria related to your income, home location, and credit/finances:
Income Limits
Your household income cannot exceed 115% of the median income in your area. The USDA publishes income limits by state and county on their website. For context, the 2023 national median household income was around $71,000.
So in an average area, you’d need a household income under $81,650 to qualify. High-cost areas have higher caps, while lower-cost rural areas may have lower limits.
Home Location
USDA loans are reserved for homes in suburban or rural locations. Eligible areas are classified as “non-urban” per USDA definitions. You can check your address to see if you’re located in a USDA-eligible area.
Credit Requirements
Most USDA lenders require a minimum credit score of 580 to qualify. Some may approve scores as low as 500 with strong compensating factors.
Your debt-to-income ratio (DTI) also needs to be 38% or lower, meaning your total monthly debt payments cannot exceed 38% of your gross monthly income.
Cash Reserve
You aren’t required to make a down payment. However, most lenders want to see you have at least 2 months of mortgage payments available in cash reserves after closing.
Other Requirements
Finally, you’ll need to provide the standard documentation required for any mortgage, including tax returns, pay stubs, and a home appraisal.
Tips for Getting Approved with Bad Credit
If your credit score falls below 640, it can take some extra planning to get approved. Here are some tips that can help your chances with a USDA loan:
Compare multiple lenders. Each USDA lender sets their own minimum credit score requirement. Shopping around can help you find options more open to lower scores.
Ask about manual underwriting. Many lenders automatically reject applicants who don’t meet the minimum credit or DTI requirements. But some will do a manual review, taking into account documents that show you can manage the mortgage responsibly.
Explain red flags on your credit report. If you have late payments or collections accounts on your report, be ready to provide notes explaining any extenuating circumstances. Documented exceptions can help offset credit dings.
Consider credit repair to boost your score. Fixing errors on your credit report, paying down balances, and resolving collections accounts can significantly lift your credit score to improve your chances of approval.
Make a larger down payment if possible. While it’s not required, putting even 3-5% down shows the lender you’re financially committed to the home. A down payment can make up for weaker credit.
Bring a cosigner. Adding a cosigner with good credit is a surefire way to overcome bad credit. Just make sure the cosigner understands and is able to take on shared responsibility for repaying the mortgage if needed.
Finding the Best USDA Lender for Bad Credit
Not all mortgage lenders participate in the USDA loan program. And among those that do, underwriting requirements can vary quite a bit.
Here are some tips for finding a lender that’s most likely to approve borrowers with low credit scores:
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Compare quotes from multiple lenders. Get rate and fee quotes from at least 3 lenders to compare options. Be sure to ask each about their minimum credit score requirements.
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Search for “soft pull” preapprovals. A soft inquiry won’t affect your credit score. This allows you to check with lenders before formally applying.
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Look for down payment assistance programs. Some credit unions and state housing agencies offer grants to help cover closing costs and down payments. Ask potential lenders about these options to reduce your out-of-pocket costs.
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Ask about low credit score requirements. Some lenders advertise that they work with credit scores in the 500s. This indicates they may be willing to manually approve applicants who fall just below conventional requirements.
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Read online reviews. Applicant reviews can give insight into which lenders work hardest to get low credit score borrowers approved. Take negative reviews with a grain of salt, but look for patterns of flexibility.
Finding the right lender can be the difference between getting approved or denied. Be sure to ask the right questions upfront so you don’t waste time applying with lenders who are likely to reject your application.
Alternatives if You Don’t Qualify for a USDA Loan
What if you still get turned down by USDA lenders despite your best efforts? Don’t give up on your home buying dreams yet. Here are some alternative options to consider:
FHA loans – FHA loans are another government-backed program that allows credit scores as low as 500. You’ll need to make a small down payment of 3.5%, but FHA loans are worth exploring if you just miss the USDA credit requirements.
VA loans – For military service members and veterans, VA loans offer benefits similar to USDA loans, with no down payment and more flexible credit guidelines.
Subprime mortgages – While higher interest rates and fees can make them less-than-ideal, subprime mortgages are specifically designed for buyers with poor credit. They may be your only option outside of government programs.
Cosigned mortgages – Adding a cosigner with good credit remains the simplest path to approval. Just be certain your cosigner can and will make payments if you are ever unable to do so.
Credit repair – Keep working to improve your credit before reapplying. Pay down debts, resolve any inaccuracies on your report, and keep accounts current. Each positive change can help boost your score.
Down payment assistance programs – Beyond the options mentioned earlier, many state and local governments offer down payment grants, subordinate financing, and affordable mortgage programs. Connect with a housing counselor to learn about programs available in your area.
Loan modifications – If you obtain a mortgage but later struggle to make payments, ask your lender about a modification. Adding your payments to the end of the loan term can provide temporary payment relief in hardship situations.
Don’t let a low credit score stop you from pursuing your homeownership dreams. Be persistent in researching programs, comparing lenders, and finding alternatives that work for your financial situation. With diligence and patience, you can find a mortgage that helps you buy the home you want.
Type Of USDA Loan Program
There are two types of USDA loans: USDA guaranteed loans and direct loans. The difference between the two lies in how you obtain the loan and the income level requirements of each loan.
USDA guaranteed loans work in a similar fashion to other government-backed loans, such as FHA loans and VA loans: the USDA insures the loan, but the loan itself is obtained through a participating lender. The lender will typically relax their criteria for eligibility since the loan is backed by the USDA. This eliminates the risk of losing money if the borrower defaults on them.
Despite the USDA’s backing, there are still a number of requirements that must be met. Besides proving that you’re a U.S. citizen or permanent resident, the estimated monthly payment for your house (including principal, interest, insurance, and taxes) can’t cost more than 29 percent of your monthly income. Any other monthly debts you have to pay can’t exceed 41 percent of your income. However, there is some flexibility–if your credit score is higher than 680, then they will consider higher debt ratios.
There are some income limits as well. Your base income limit must be less than 115 percent of the area’s median income. There are also a few household income limits you must meet. For a household with four or fewer people, your household income can’t be more than $82,700. For households with five to eight members, it can’t be more than $109,150. Finally, the property must be your primary residence.
If your income is low or very low, which is determined by the income threshold established by the USDA for direct USDA loans (which varies from one area to another), then you may be eligible for a direct USDA loan. This means that the USDA will issue the loan to you directly, not through a lender. With the use of subsidies, your USDA loan’s interest rate could be as little as one percent.
The majority of the requirements are the same for a direct loan as a USDA guaranteed loan; however, there are a few differences, mostly in terms of the income limits. The base income limit is between 50 and 80 percent of the area’s median income. The household income limit for one to four-member households is $50,100. For five to eight-member households, it’s $66,150.
In addition to being your primary residence, the house you’re purchasing can’t be more than 2,000 square feet.
What makes the USDA loan particularly unique is that it doesn’t just have to be used towards the purchase of a house. USDA loans can also be taken out to cover the costs of home improvements or repairs. The USDA provides grants and loans for any home improvement that removes health and safety hazards or improves accessibility.
Up to $20,000 is available via home improvement loans and grants that can be used towards repairing or replacing furnaces, electrical work, foundations, siding, appliances, roofing, plumbing, wells, windows, septic systems, and more. Interest rates are fixed at one percent for terms of up to 20 years. To be eligible, your household income cannot exceed 50 percent of the area median income and must be located in a rural area.
Although the USDA does not set a minimum credit score requirement, most lenders set their own minimum credit score requirement for any USDA loans that they issue at 640.
Quick Overview Of USDA Loan
The USDA loan is a government-backed loan offered by the U.S. Department of Agriculture (USDA). It was established as a way to encourage home buyers to purchase property in more rural and suburban areas of the country, thereby helping to promote and improve both the economy and the quality of life in those areas. Several of the benefits to taking out a USDA loan include the zero down payment requirement and the low-interest rates.
5 Things You Need to Know About USDA loans
FAQ
Can you get a USDA loan with a 500 credit score?
Why would you get denied for an USDA loan?
Can you get a USDA loan with a low credit score?
However, the USDA does not have a hard and fast credit score requirement, so borrowers with low scores may still be eligible to qualify for a USDA-backed home loan. Let’s break it down. What is the minimum credit score for a USDA loan? Approved USDA loan lenders typically require a minimum credit score of at least 620 to get a USDA home loan.
Can I get a USDA loan if my credit score is 620?
Approved USDA loan lenders typically require a minimum credit score of at least 620 to get a USDA home loan. However, the USDA doesn’t have a minimum credit score, so borrowers with scores below 620 may still be eligible for a USDA-backed mortgage. If your credit score is below 620, there’s still hope.
What credit score do you need for a USDA loan?
Credit Requirements Borrowers must have a minimum credit score of 620, but aim for a score of at least 640 if you’re seeking a USDA loan. Guild Mortgage is a nationally recognized independent mortgage lender that offers USDA loans with “better-than-average” interest rates and a low credit score requirement.
What if I can’t get a USDA loan?
If you’re having trouble getting approved for a USDA loan, other mortgage programs could offer a good alternative. For example, FHA loans require only 3.5% down, allow lower credit scores starting at 580, and have no income limits or geographic requirements.