Do you prefer rural living to the hustle and bustle of city life? You may want to consider USDA financing then. You can borrow 100% of a home’s purchase price with this program! Of course, it has specific guidelines, but luckily, you don’t need a high credit score to qualify.
Want to learn more about this innovative program? Read on.
The Minimum Credit Score
The USDA requires a minimum credit score of 640. In the eyes of FICO, this is a ‘fair’ score, if that tells you anything. The USDA does not require an exceptional credit history. Fair means below average – most lenders look at borrowers with this score as a high risk for default. Generally, they would turn borrowers down with a score this low.
So what’s the difference with the USDA program? It’s the guarantee the USDA provides. This government-backed program helps the lender in the face of default. USDA approved lenders can lend to borrowers with a score as low as 640 and borrow 100% of the purchase price. If the borrower defaults, the USDA will pay the lender back a portion of the money they lost.
What do Lenders Say?
Now, just because the USDA allows a credit score as low as 640 doesn’t mean every lender feels the same way. Lenders must follow the USDA’s requirements, but they can make those requirements even harder if they wish. It’s called lender overlays.
The USDA does not fund the loan. The lender does the funding. That means it’s the lender’s money that is on the line, even with the USDA guarantee, no lender wants a defaulted loan. If a lender does not feel comfortable with a 640 score, they can set their minimum requirement higher.
How to Get a Low Credit Score Approved
Don’t get discouraged if you have a credit score around 640, it won’t be impossible to find a lender. There are many USDA approved lenders that strictly use the USDA guidelines. However, there is one way you can increase your chances of approval – you need compensating factors.
Because a lender looks at you as risky if you have a fair credit score, you want your other factors to make up for the risk. Here are a few ways you can do this:
- Have stable employment – The longer you are at the same job, the less risk you pose. A borrower that hops from job to job does not provide consistency. The lender cannot count on his income and looks at him as a high default risk. Instead, staying at the same job provides predictability and less risk.
- Have assets – The USDA program does not require assets on hand, but they speak volumes, especially if you have fair credit. Put some money aside in savings and use it as reserves on your mortgage application. It offsets the risk of your low credit score.
- Low debt ratio – Minimize your debts before you apply for the USDA loan. The lower your debt ratio, the less your money gets spread out each month. Lenders can then rely on the fact that you’ll focus on paying your mortgage rather than other debts.
One or more of these compensating factors can help make up for a fair credit score. That doesn’t mean an automatic approval, but it gives lenders food for thought when determining your eligibility.
Are you Eligible for the USDA Loan?
Something else to keep in mind is the eligibility requirements for the USDA loan. This is different than the qualifying factors. Only certain borrowers will be eligible for the program. They include:
- You must not be able to qualify for any other mortgage program including FHA, VA, and conventional loans
- Your total household income must be less than 115% of the median income for your area
- The home must be located in a rural area
If you are not eligible for the program, a lender cannot process your application. Once you are eligible, though, you still have to qualify for the program. This means having a least a 640 credit score and a debt ratio no higher than 29/41. This means 29% of your gross monthly income can cover the mortgage payment, but no more than that. It also means your total debts, including credit cards, car loans, and student loans cannot exceed 41%.
It’s safe to say the USDA financing is very flexible, but it does have its requirements. Talk to a lender to see if you are eligible for the program. If so, work on your qualifying factors so you can take advantage of one of the most flexible programs on the market today.