Bad credit doesn’t automatically preclude you from buying a home. You still have options – and a USDA loan is one of them.
USDA loans are designed to make homeownership more accessible to Americans, and they come with looser credit standards and income requirements than other types of mortgage loans. This makes them an ideal choice for buyers with less-than-ideal credit scores.
A credit score is essentially an assessment tool – a grade of how well you’ve managed and paid off your past debts, as well as how you’re tackling any current debt. FICO credit scores range from 300 to 850.
For a mortgage lender, your score represents your ability to repay the loan they’re giving you. A higher score indicates you’ve paid your bills on time, have low debt levels and will more than likely pay your mortgage as promised. While lower scores don’t necessarily mean the opposite, they do give lenders reason to pause and consider an applicant more stringently.
Your credit score is inevitably going to play a role in what type of loan you can get, as well as what rates you qualify for, but it’s important to note that every lender sets their own criteria for evaluating borrower credit. While one lender may consider only borrowers with 720 scores and above, the next may accept credit scores as low as 580 or even less.
The USDA does not set a minimum credit score requirement, but most USDA lenders typically look for a credit score of at least 640, which is the lowest score allowed for the USDA's Guaranteed Underwriting System (GUS). GUS allows lenders to automate the credit risk evaluation process.
Aside from your score, USDA lenders also want to see a strong payment and employment history, as this indicates your ability to repay your loan is high. They’ll also look at your total debt-to-income ratio, which compares your major monthly debts to your gross monthly income.
If your credit score is under 640, you might still be able to get a USDA loan – it just requires that an underwriter manually process your application.
If your credit score is under 640, you’ll need to have some “compensating factors” to convince lenders you’re still a safe bet. Compensating factors can include savings accounts, a college degree, a solid rent payment history and low debts.
If you’re worried about your credit score hurting your chances at a USDA loan, the best thing to do is to boost your credit before applying. Paying off just one credit card or removing one account from collections can have a huge influence on your score and your chances of getting your loan.
To improve your score, start by setting up automatic payments of all your bills. Timely payment plays a huge role in your score, and ensuring your future bills are paid on time, every time can have a big impact.
You’ll also want to address any collections issues. If an account has been sent to collections, pay off the outstanding bill or contact the creditor to set up a payment plan. Collections can hurt your score and your shot at a loan.
Start paying down your existing debts, too. If you have credit cards or other high-interest balances, focus on paying those first. Put down a little extra each month to start lowering those balances.
Don't sign up for any new credit card or loans, as these will result in hard inquiries of your credit and lower your score.
You’ll also want to steer clear of any large purchases, especially on credit cards. Aim to keep your credit card balances under 30 percent of your credit limit.
Finally, do everything you can to avoid late payments. Payment history is the single biggest influencing factor in your credit score. Just one late payment could derail your homebuying plans.
With looser credit and income standards, no down payment requirements, and often, lower closing costs, USDA loans can be a great option for borrowers with less-than-ideal credit scores.