The USDA loan is one of the few loan options that offer 100% financing. You have to be a low to moderate-income family and you must buy a home in a USDA designated rural area in order to qualify. Finding a home in a rural area is pretty easy to figure out, but it’s the USDA income requirements that may make you stumble.
The USDA income guidelines take into account the income of everyone over the age of 18 in your household. Even if the household members aren’t on the loan, they have to disclose their income. In the past few years, the USDA has gotten a little stricter with this requirement by requiring borrowers to supply their tax returns. It’s not the way you might think, though.
Keep reading to find out how it works.
The IRS Tax Transcript Requirements
You may not have to provide your copy of your tax returns to prove your household income, but the lender does have to request your IRS transcript. This means you and every household member will have to complete IRS Form 4506 T. This form gives the lender permission to access your IRS tax transcript.
The tax return transcript shows the basic information about your tax return so that the lender can verify what you supplied is the truth. It is a summary of what you filed, but it also shows your adjusted gross income. The lender then uses this to verify that you provided the same information.
If the information matches what you told the lender, the lender can then move forward processing your loan. Their first order of business is to make sure that you meet the income guidelines for your area. You cannot make more than the allotted amount for your family size and your area. In general, you can’t make more than 115% of the average income for the area.
Qualifying Your Income
Once you know that you are eligible for the loan, you then have to prove that you qualify for it. Will you need your tax returns for this step too? It depends on the type of income you earn. Typically, if you are a salaried employee or you work full-time on an hourly salary, you won’t need to provide your tax returns for qualifying purposes.
On the other hand, if you work on commission (more than 25% of your income is commission) or you own your own company, you will need to provide your tax returns. In this case, you’ll likely need to provide the tax returns for the last 2 years. This gives the lender the opportunity to average your income over that time.
Why would a lender need two years of income? It’s because of the volatile nature of both commission income and self-employed income. When you don’t receive a salary, your income likely has ‘ups and downs.’ If the lender were to qualify you on your income when your income was ‘up,’ you might qualify for more mortgage than you can afford year-round. If the lender qualified you for a loan when your income was ‘down,’ they may short change you. Taking that 2-year average helps the lender know that you can afford the payment year round.
Other USDA Loan Requirements
Aside from proving that you can afford the loan, you’ll need to show the lender other factors to ensure that you qualify for the USDA loan program:
- 640 minimum credit score
- 29% total housing ratio (your housing payment shouldn’t exceed 29% of your gross monthly income)
- 41% total debt ratio (your total debts shouldn’t exceed 41% of your gross monthly income)
- Proof that you will live in the home as your primary residence
- Proof that you can’t qualify for any other loan program
The USDA loan provides 100% financing, as we discussed above. This means you don’t have to put any money down on the home, but you do have to cover the closing costs. The only way that you can roll the closing costs into your loan is if the house appraises for more than the amount you agreed to pay. If this is the case, you may be able to increase your loan amount to cover the closing costs.
Keep in mind, that you’ll also pay mortgage insurance on the USDA loan. You will pay 1% of your loan amount at the closing (or rolled into your loan) and 0.35% of the outstanding balance each year, paid on a monthly basis. In other words, the lender takes the annual premium and divides it equally amongst your 12 monthly payments. You pay the insurance along with your mortgage payment. This insurance lasts for the life of the loan.
In short, USDA loans do require tax returns, but typically not for qualifying for the loan. It’s more to prove your household’s eligibility for the 100% USDA loan program. The IRS transcripts are typically easy to obtain as long as you provide the proper form. If there is an issue and the lender cannot obtain them, you can request them yourself and provide them to the lender, if they request this of you.