Can you qualify for a USDA home loan with a charge off on your credit report?

By Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Edited by Michael Jensen, Mortgage and Finance Guru

Updated October 20, 2020

Your ability to qualify for a USDA home loan with a charge off on your credit report depends on your credit score and how your lender processes your mortgage application. If your credit score is at least 640 and your lender uses the USDA's Guaranteed Underwriting System -- an automated underwriting system also known as GUS -- then you should be able to qualify for a USDA home loan despite the charge off.

In short, underwriting is the process that lenders use to review and approve your loan application. If your credit score is above 640 and there are no other significant issues with your loan application or credit report, lenders typically use automated underwriting to process your mortgage.

In this case, you do not need to take any specific action to address the charge off.  Specifically, you are not required to pay off the charge off or establish a payment plan.

According to USDA home loan guidelines, the negative effect of the charge off is already factored into your credit score so there is no need to assess a separate penalty or other requirement related to the charge off.  Additionally, unless you are currently making payments to resolve the charge off, which would be unusual, it is not factored into your debt-to-income ratio, so it has no impact on the mortgage you qualify for.

Use ourUSDA HOME LOAN QUALIFICATION CALCULATORto determine the mortgage you can afford based on your monthly income and debt expense

If your credit score is less than 640 due to the charge off or other reasons, your lender may be required to manually underwrite your mortgage application.  In this scenario, your lender is usually required to submit a "credit exception" with your application that explains why your loan should be approved, despite your relatively low credit score, which may in part be caused by the charge off.

Please note that having a charge off does not automatically mean that you are required to provide a credit exception, even if your application is manually underwritten. But if you are required to provide a credit exception to address an issue that is related to the charge off -- such as a low credit score -- you may be required to address the charge off as well either through a letter of explanation or other action.

A credit exception usually includes written explanations from both you and your lender that describes the circumstances that led to the derogatory credit event, the steps that you took to address the issue and the reasons why you should qualify for the mortgage. In this scenario it can also be helpful if your application has supporting factors in other areas such as a low debt-to-income ratio or significant financial reserves. 

Please note that manually underwriting a loan application and including a credit exception requires additional effort and documentation by you and your lender. Not all lenders are willing or able to perform this extra work so make sure you choose a lender that has experience in this area.

To summarize, qualifying for a USDA home loan with a charge off if your credit score is less than 640 can be more challenging. You and your lender may need to put in more effort and the USDA may be required to grant you an exception to get approved for the mortgage.  

We should highlight that no matter how your application is underwritten -- automated or manually -- USDA home loan program guidelines do not require applicants to pay off charge offs although in some cases this may be helpful, especially for credit-challenged borrowers.  We advise you to work with your lender to determine the approach that is right for you.

Keep in mind that if you decide to enter into a payment plan to settle the charge off, the payment is included in your debt-to-income ratio, which may reduce the loan amount you can afford.  Although we should also reiterate that paying off a charge off is usually not required to qualify for a USDA home loan. 

One additional point I should mention is that the guidelines outlined above apply to the USDA guaranteed home loan program and not the USDA direct home loan or USDA streamline refinance programs. For example, in most cases, having a charge off within the past three years prevents you from qualifying for a USDA streamline refinance.

We recommend that you contact multiple lenders in the table below to confirm that they work with applicants with charge offs and to learn more about their qualification requirements.  Comparing multiple lenders also enables you to find the best mortgage terms. 

Sources

"Chapter 10, Attachment 10-A, Charge-Offs."  Single Family Housing Guaranteed Loan Program Technical Handbook.  U.S. Department of Agriculture, 2020.  Web.

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