Castro is the mayor of San Antonio and is seen as a possible Democratic vice presidential nominee in 2016. If confirmed by the Senate, Castro would become one of the highest-ranking Hispanic officials serving in the government.
Obama says Castro has helped revitalise San Antonio, experience he will draw on as head of the Department of Housing and Urban Development.
The move is part of a broader shuffle of Obama's Cabinet that includes nominating current housing chief Shaun Donovan to run the Office of Management and Budget. During a White House ceremony, Obama praised Donovan's efforts to help the US housing market recover from the recession.