Are you classifying it a rug yarn because of the texture (coarseness) of the yarn?
You can use it for anything you wish. The question would be if it will feel nice next to your skin. I suggest doing the ‘bra test’ … take a piece of yarn and tuck into your bra and take it along with you for the day. If it doesn’t bother you, then knit to your heart’s content!
I wash all my hand woven rugs by filling the tub with enough water & mild detergent to cover the rug, then I let it soak, giving it a couple gentle swishes a few times. Drain the tub and repeat until clean then rinse the same way.