For those wanting to buy a home with as little down as possible and still get competitive interest rates, the USDA home loan program should be explored. The USDA loan is the only non-VA mortgage that requires no down payment whatsoever. Zero. Other low down payment loans such as conventional mortgages increase the interest rate to the point where many no longer qualify for the home they want, simply because of the lack of a 20 percent down payment.
The USDA loan however does have some restrictions and isn’t for everyone. Both the borrower and the property must qualify separately. The property must be located in a geographical area identified by the USDA. Most acceptable areas are considered rural. Yet semi-rural and even some suburban areas are also in acceptable zones. While the program was originally aimed at helping borrowers finance properties in very rural areas, today those areas may be nothing like rural at all.
The USDA keeps a website where potential buyers can type in a property address to see if the home is an approved area. If so, the borrowers then take the next step and apply for the loan. USDA loans as that the borrowers are able to afford the new monthly payments as well as show an acceptable credit history. How do USDA lenders evaluate credit and income?
Credit Requirements for USDA Loans
Lenders today use credit scores to help evaluate credit. These credit reports are specifically designed for mortgage companies and also provide a three digit score ranging anywhere from 300 to 850. The higher the score, the better the credit. USDA does not however insist the borrowers have any specific score however USDA lenders do and most ask for a score of 640 although there are USDA lenders that will take a score as low as 600. For borrowers without a credit history or no credit score, some USDA lenders apply “alternative” credit standards where rental history is verified along with timely payments on utilities or mobile phone accounts.
There are three main credit repositories for USDA loans, Equifax, Experian and TransUnion. With three repositories there will be three credit scores, all typically within a tight range. For instance, a borrower might have scores of 680, 677 and 665. Lenders will throw out the highest and the lowest scores and use the middle. For two or more borrowers on the same application, lenders will typically use the lowest middle score.
USDA lenders look primarily at the previous 12 months of credit history as well as verifying the most recent year’s rent payments. Perfect credit isn’t required and there can be some blemishes but the further back those blemishes are, the better, especially if the previous 12 months show timely payment. If there is a previous bankruptcy, USDA lenders ask that at least two years go by and credit reestablished before evaluating a new USDA loan application.
Income Requirements for USDA Loans
The USDA loans require lenders to verify the borrowers can afford the new monthly payments in addition to any they currently have. This is done by comparing gross monthly income with the new debt and calculating a debt ratio. The maximum debt ratio most USDA lenders allow is 43 percent. That means if a borrower’s mortgage payment, including taxes, insurance and the annual fee is $1,200 and there is a car payment of $400, the total debt is $1,600. If the gross monthly income for the borrowers is $4,200, the ratio is then calculated at $1,600 divided by $4,200 = .38. 38 is below the 43 ceiling and is an acceptable number.
Income is verified by reviewing the most recent pay check stubs covering 30 days as well as the most recent two years’ W2 forms. For self-employed borrowers, USDA lenders also require the two most recent federal income tax returns.
Income for USDA loans is also limited. Generally speaking, all members of the household 18 and older and working must make no more than 115 percent of the gross median household income for the area. It’s very important to note here that the 115 percent number is not the final arbiter. There are other considerations and deductions from gross household income that must be included when determining maximum allowable income. If you’re near this 115 percent amount, it’s critically important you let an experienced USDA loan officer make these calculations for you to make sure you do or do not qualify. For some, they automatically disqualify themselves for this special loan program because they believe they make too much money. Don’t make that same mistake. Find out for sure and call a USDA lender.