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What is a USDA Loan and How Do I Qualify for One?

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You can buy a home in a rural area with no down payment with a loan guaranteed by the U.S. Department of Agriculture (USDA). USDA loans are designed to help low- to moderate-income borrowers interested in rural living become homeowners with affordable mortgage financing.

What are USDA loans?

USDA loans are mortgages that require no money down and are guaranteed by the USDA. The USDA guarantees 90% of the loan note, reducing the risk lenders take on by offering 100% financing to USDA borrowers. In turn, USDA-approved lenders offer no-down-payment mortgages to low- to moderate-income borrowers so they can buy or refinance homes in USDA-designated rural areas.

The USDA defines “rural” areas as open country or any town, village, city or place that’s not part of an urban area and has:

  • A population of no more than 2,500 people
  • A population between 2,500 and 10,000 if it’s rural in character
  • A population between 10,000 and 20,000 but isn’t part of a metropolitan statistical area and lacks mortgage programs for low- to moderate-income families

Borrowers can choose from three main USDA housing programs:

  1. Single-Family Home Guaranteed Loan Program (SFHGLP). Private USDA-approved lenders offer the Section 502 Guaranteed Loan to borrowers who are buying or refinancing existing USDA loans in approved rural neighborhoods. While no down payment is required, there is one catch: Borrowers’ incomes cannot exceed the income limits for their area.
  2. Direct Single-Family Loans. Also known as the Section 502 direct loan program, these loans are aimed at very low- and low-income borrowers and require no down payment with terms up to 38 years. The loans are funded by the USDA with notably low interest rates set by Rural Housing Services, and you apply directly through the USDA for them.
  3. USDA Section 504 loans and grants. Rural homeowners who have very low incomes and own “modest single-family homes” might be eligible for a Direct USDA loan to upgrade their home or make repairs. Homeowners 62 and older who cannot repay a loan may be eligible for USDA grants to pay for necessary safety repairs or remodel a home to accommodate disabled family members. Section 504 loan and grant applicants apply for these programs directly through the USDA.

What is the USDA?

Former President Abraham Lincoln established the USDA in 1862 to meet the needs of half of all Americans who lived on farms at the time. Today, the USDA comprises 29 agencies, including Rural Housing Services, which provides home loan programs for single-family and multifamily rural housing as well as grants and loan guarantees to private USDA-approved lenders. As of August 2020, the USDA had backed more than $21.6 billion in loans, loan guarantees and grants made to rural homebuyers.

USDA loan requirements

USDA-approved lenders must follow borrowing guidelines set by the USDA in order to qualify. USDA loan requirements are different from other government-backed loan programs, with strict limits on household income and where your home is located.

Key USDA loan qualifications include:

  • Income limits. USDA guidelines require that a household’s income must be at or below 115% of the median household income in a neighborhood. Use the income eligibility search tool on the USDA website to find out the income limits in your area.
  • Household income of all adults. The USDA doesn’t just count income from borrowers applying for a USDA loan. Income from all adult household members is analyzed to ensure it doesn’t exceed area limits.
  • Employment requirements. USDA loan guidelines require a year’s worth of employment history. Self-employed borrowers need to show a two-year employment history.
  • Credit score. The minimum credit score for a USDA loan is set by the lender you choose. The USDA has no set score requirement, but most lenders prefer at least a 640 minimum. If your score is lower, you may have to meet additional conditions to prove you can repay the loan.
  • Debt-to-income (DTI) ratio. Lenders use DTI ratio, which is calculated by dividing your total monthly debt payments (including the new mortgage) by your gross monthly income, to help determine your ability to repay a mortgage. The maximum USDA debt-to-income ratio allowed is 41%. To qualify for a USDA loan, your monthly mortgage payment (including principal, interest, taxes and insurance, or PITI) can’t exceed 29% of your income. Borrowers with a 680 score may qualify with a higher PITI ratio of 32% and a total DTI ratio of 44% with steady income and extra cash reserves.
  • Guarantee fees. USDA loans don’t require mortgage insurance like other loan types, but they do have guarantee fees. Much like the VA funding fee, the guarantee fees offset the cost of the USDA program to U.S. taxpayers. The current USDA guarantee fees are:
    • 1% of the loan amount for the upfront guarantee fee, which is typically rolled into the loan
    • 0.35% of the loan amount charged annually, divided by 12 and added to the monthly payment
  • Down payment. Eligible USDA borrowers don’t need a down payment, and mortgage reserves aren’t required unless you have a high DTI ratio. There’s also no limit on using gift funds if you do wish to make a down payment.
  • USDA property eligibility. Only single-family homes, planned-unit developments (PUDs), condominiums, modular and manufactured homes in USDA-approved rural areas are eligible.
  • Occupancy. You must live in the home as your primary residence.
  • Residency. You must be a U.S. citizen, noncitizen national or a qualified resident alien to get a USDA loan.

Why USDA property eligibility is important

The USDA program is meant to finance only homes in eligible rural areas designated by the USDA. You can use the USDA property eligibility link to check on a home’s USDA loan eligibility by entering the full address.

USDA designations may change periodically based on Rural Development area requirements, so the maps on the website may not be current. Your lender will re-confirm the property’s USDA loan eligibility once it receives your full loan application.

Pros and cons of USDA loans

Pros

  • No down payment required
  • No minimum credit score (although 640 is the preferred lender minimum)
  • Lower guarantee fees than other government-backed loans
  • No mortgage reserves are necessary

Cons

  • Homes must be in USDA-approved rural areas
  • Loan terms are limited to a 30-year, fixed-rate mortgage
  • Income limits may restrict how much home you can buy
  • DTI ratio maximum is lower than other government-backed loans

How USDA loans work

The basic moving parts of a USDA loan are similar to other types of mortgages. You fill out a loan application, provide income documents and the lender pulls your credit to review your credit history. However, lenders must take extra steps to approve a USDA loan application. These steps include:

Your USDA application through the Guaranteed Underwriting System (GUS). Your application information is submitted through an automated underwriting system designed specifically for USDA loans. Only USDA-approved lenders have access to the system to verify the property is in an acceptable USDA rural area and that your income doesn’t exceed the limits for your area.

You must have a clear CAIVRS report. The Credit Alert Interactive Verification Reporting System (CAIVRS) is checked to confirm that you haven’t defaulted on any federal debt.

You must complete a homeownership education course. First-time homebuyers must complete a homebuyer education course to get a USDA loan, and it’s recommended that you do so early in the application process. Lenders must provide a list of approved courses, which can cost anywhere from $60 to $75.

How do I apply for a USDA loan?

You can check the list of USDA-approved lenders in your state, ask for referrals from friends or relatives who already have a USDA loan or use a rate comparison tool to have lenders call you. However, if you’re applying for a USDA Direct loan or grant program, you’ll apply directly through your local USDA Rural Development office.

Steps to apply:

  1. Check the income limits in your area to make sure you qualify
  2. Find a USDA-approved lender
  3. Complete a first-time homebuyer education course, if applicable
  4. Make sure the homes you’re searching for are USDA-eligible
  5. Fill out a loan application
  6. Provide income, asset and credit information to your lender

Types of USDA loans

  • Regular purchase loans. Borrowers who meet the income requirements can purchase a home in an USDA-eligible rural area with no down payment. Closing costs can be added to the loan, as long as they are reasonable.
  • Regular refinance loans. Homeowners who closed on a USDA loan at least 12 months ago can refinance to lower their payment and roll in closing costs up to 100% of their home’s new appraised value with the USDA’s non-streamlined refinance program. A home appraisal and income verification are required.
  • Streamlined-assist refinance loans. No appraisal or income documents are required for homeowners with a current USDA loan. As long as you can save at least $50 or more per month and closed your loan at least 12 months ago, you might qualify.
  • Single close construction-to-permanent loan. Qualified borrowers may be able to take out a loan that funds the construction costs of a new home, and automatically converts to permanent mortgage with the USDA’s combination construction-to-permanent loan. Also called a single-close loan, the program is available in approved rural areas with populations up to 35,000.
  • Repair and construction loans and grants. Very low-income homeowners may be able to finance the cost of repairs and construction to update a home with the Section 504 USDA loan program. Homeowners 62 and over may also be eligible for grants to remove safety hazards in their home or remodel it for disabled family members.

The USDA doesn’t allow cash-out refinancing. Although you can add closing costs to your loan amount with a USDA refinance loan, you cannot withdraw cash from the home equity you’ve built through the USDA program.

USDA vs. FHA loans

USDA borrowers may also consider loans backed by the Federal Housing Administration (FHA), if they have lower credit scores or a household income above the USDA area limits. The table below compares USDA loans versus FHA loans side by side.

Loan requirement USDA loans FHA loans
Down payment 0% 3.5% with a 580 credit score

10% with a credit score between 500 and 579

Minimum credit score 640 580 (with 3.5% down)

500 (with 10% down)

Mortgage insurance/guarantee fees 1% of loan amount for upfront guarantee fee

0.35% of loan amount for annual guarantee fee

1.75% of loan amount for upfront mortgage insurance premium

0.45% to 1.05% of loan amount for annual mortgage insurance premium

PITI ratio 29% (with exceptions up to 32% possible) 31% (with possible exceptions)
Total DTI ratio 41% (with exceptions up to 44% possible) 43% (with exceptions possible)
Income limits Yes No
Property location limits Yes No

FAQs for USDA loans

Is it hard to get a USDA loan?

Yes. The strict property, credit score and income requirements may make it more difficult to qualify for USDA financing than other types of government-backed loans.

Do you have to pay back a USDA loan?

Yes. USDA loans are secured by your home, and you can lose your home to foreclosure if you fall behind on payments.

How long do you have to live in a USDA loan home?

Homeowners must live in a USDA-financed home as their primary residence for the full term of the loan. In other words, you cannot use a USDA loan to buy a vacation or investment home.

Is a USDA loan better than a conventional loan?

USDA loans are ideal for borrowers with lower incomes who don’t have any money for a down payment and want to buy a home in a rural area.

What disqualifies a home from USDA financing?

USDA loans cannot be used to buy a home outside of USDA-designated rural areas.

How long do you have to be employed to get a USDA loan?

You need to verify continuous employment for at least 12 months. Self-employed borrowers must prove two years of employment history. Remember that USDA-approved lenders look at the total household income of all adults living in the home, not just the borrowers.

Is the USDA loan limited to first-time homebuyers?

No, but if you are a first-time homebuyer, you’ll need to complete an approved homebuyer education course before your loan closes.

 

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