Qualifying for a USDA loan requires not only approval on your financials, but also on the property itself. Aside from the value and condition of the property, the USDA requires a specific location for the home. Only rural homes are eligible for the program. Before you concern yourself with the property boundaries, though, you need to determine if you are personally eligible for the program. If you want an exact minimum credit score to guide your eligibility, it is 640. This comes with caveats, though. It does not mean if your score is less than 640 that you are not eligible. You will just have different guidelines to follow.
Automated Underwriting Requirements
The credit score of 640 is only necessary for borrowers seeking automated approval. This means a computer program states you are eligible for the program. You have minimal conditions to meet and you can close quickly. Keep in mind, though, the automated program requires your debt ratios to be equal to or less than 29/41. If you exceed these ratios, a manual underwrite is necessary. This means your full housing payment (principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance) cannot exceed 29% of your gross income. It also means your total monthly debts (credit cards, car payments, and mortgage) cannot exceed 41% of your income.
If you meet the automated underwriting guidelines, you may only have to provide minimal documentation. This includes:
- Last 2 paystubs to prove your income
- Last 2 W-2s to show your income history
- Asset statements for any reserves you need or money you need for closing costs
- Any miscellaneous documents the underwriter needs
Manual Underwriting Requirements
If you do not meet the necessary requirements for automated underwriting, you have another option. Manual underwriting just means an underwriter reviews your file and determines if you are eligible. The good news is the credit score requirements decrease. You only need a minimum score of 600 to qualify. Underwriters use the middle score of you and any co-applicants to determine eligibility. The bad news is the underwriter will comb through your file with greater scrutiny. However, the benefit of a human looking at your file is they understand “real life.” They can make exceptions for one-time occurrences or unusual circumstances. A computer program has strict guidelines that have no “grey area” so to speak. Sometimes a manual underwrite can work to your benefit.
Compensating Factors Help
Compensating factors are things that make your low credit score a non-issue. They are things that make the underwriters believe you can pay the loan back despite a spotty credit history. Every lender requires different compensating factors. For example, one lender might think a low debt ratio is enough to overlook a 605 score. Another lender may not agree.
The most common compensating factors include:
- Cash left over after closing. Lenders consider these “reserves.” They measure them based on how many months’ of mortgage payments you can cover with it. The more reserves you have, the better your chances of approval.
- The possibility of a raise or promotion based on recent training or education you received.
- No payment shock, meaning you are used to making payments similar in size to the pending mortgage payment. Lenders can use your current rent or mortgage payments to measure this.
- Very few outstanding debts combined with responsible use of your credit in the past. Lenders usually look back over the last 12 months to determine this.
There are many more possibilities regarding compensating factors. They are up to each lender and individual underwriter. Every lender will look at the big picture, though. For example, they cannot use the fact that you have 6 months of reserves to approve a credit score of 600 if you have a high debt ratio. They need to put everything together to see the risk level you pose to make a decision.
Your Credit History is Important
Almost more important than your credit score is your credit history. Again, lenders look back at the last 12 months, at a minimum. Ideally, they do not want to see more than one 30-day late payment in the last year. Some lenders require no late payments within this timeframe, though.
Keep in mind, some lenders go back as far as a few years ago to see your payment patterns. They want to determine if you have a history of paying your debts late. For example, you may have a clean credit history for the last 12 months, but the year before you had several episodes of late payments. If the lender sees this pattern occur over a few years, it may raise a red flag. They may wonder if your late payment episodes will occur again in the coming months. In this case, they may ask for a Letter of Explanation regarding the late payment episodes to determine your eligibility.
The best way to prepare for a USDA mortgage is to clean up your credit as early as possible. Make sure you make your payments on time. If you can, pay your debts down as much as you can. You also need to make sure no creditors file any new collections or judgments against you. This can affect your credit score as well as your clean credit history.
The USDA requires lenders to carefully evaluate any loan file with a score lower than 640. Don’t let this deter you from applying, though. If you cleaned up your credit history and have compensating factors to show, you have a good chance at approval. The underwriters will probably ask for more paperwork and look further into your history than they would with a higher score, though. Waiting until you have at least a few years of good credit history is the best way to increase your chances of approval.
Regardless of your credit score right now, you should shop around with different lenders. Some lenders have a higher threshold for risk than others. Shopping around gives you the chance to secure an approval as well as determine the lowest interest rate available to you.