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What Is a USDA Direct Loan?

USDA direct loan

Some 60 million people now live in rural areas around the U.S. If you are a first-time homebuyer in one of these areas, you may want to know more about the various loans the U.S. Department of Agriculture (USDA) offers to borrowers who might not ordinarily be able to afford a home on their own.

The loans are administered either directly through the USDA or through lenders who offer USDA-guaranteed loans, and they are available for properties in specially designated rural areas with fewer than 35,000 inhabitants.

USDA loan programs are geared to low- and very-low-income borrowers to help them buy modest homes that are safe and sanitary. First-time buyers have the option of taking out a USDA loan through the guaranteed lender program, but they may receive more favorable terms with a direct loan. These loans are available either for a single-family home or a multifamily property that will be used by residents who are low-income, elderly or disabled.  

Here is a guide to help you better understand how a USDA direct loan works and whether you might be eligible:

What is a USDA direct loan exactly?

A USDA direct loan is part of the Section 502 Direct Loan Program, and the two loan names are often used interchangeably. The program was created to help low-income buyers purchase safe, sanitary homes in rural areas with some assistance from the USDA. The loans are basically a form of payment assistance that buyers receive to both qualify for a mortgage and help bring monthly mortgage payments down. The amount of assistance depends on a buyer’s income and family size. For an overview of the program, go here.

When you are approved for a USDA direct loan for a single-family home, you are typically not required to provide a down payment, as long as you meet certain income requirements (see below). However, applicants who have more than the asset limit for a USDA direct loan may be required to use a portion of their assets as a down payment. Either way, buyers who qualify for a USDA direct loan may not be required to pay an origination fee, nor will they have to pay private mortgage insurance (PMI), which lenders typically charge when a down payment is less than 20% of a home’s cost.

Single-family buyers who want to take advantage of a direct loan can do so through the Single Family Direct Home Loans program, which comes with a fixed interest rate that can vary based on the amount of assistance you receive. According to the USDA, when the payment assistance is taken into account, a homebuyer’s mortgage interest rate with this loan may be as low as 1%. Loans are typically offered in terms that last 33 or 38 years, although loans on manufactured homes have a 30-year limit.

For buyers looking to buy and rent a multifamily residence in a rural area, the USDA offers Multi-Family Housing Direct Loans.   

With these loans, the main caveat is only families or individuals with very-low-to-moderate income, elderly people ages 62 or older or people with disabilities can reside in the property. The loans last for 30 years and come with competitive interest rates.

How is a direct loan different from a guaranteed loan?

With the USDA Single Family Housing Guaranteed Loan program, buyers work with third-party lenders to get their loans. Like USDA direct loans, the loans are available for borrowers with low-to-moderate incomes, although maximum income limits to qualify are higher.

While guaranteed loans are made through select lenders, the USDA backs 90% of the loan amount. This limits risk on behalf of the lenders, making it easier for them to offer loans with no money down.

Consumers can also use the guaranteed loan program to purchase, rebuild, rehabilitate or relocate a property in an eligible rural area provided they meet income and other eligibility requirements. As with USDA direct loans, you can qualify only if you plan to occupy the property yourself.

Guaranteed loans tend to be more expensive overall. In most cases, you will not be required to put money down, but you will need to pay an upfront financing fee of no more than 3.5% and an annual fee of no more than 0.5% of your loan amount.  

USDA guaranteed loans come with fixed 30-year payback times, and the loans must amortize during that time. Interest rates are also fixed, although your rate will depend on your lender. The interest rate for a USDA single-family direct home loan is now 3.75%. With guaranteed loans, lenders are allowed to set rates more in line with the mortgage market.

USDA direct loan requirements

If you think you might qualify for a USDA direct loan, it’s important to understand the eligibility requirements in their entirety. For one, there are requirements for both the applicant and for eligible properties, and these can vary dramatically depending on where you live. Finally, you should know that if you sell your home or move out, you’ll be required to pay back the subsidy that came with your direct loan.

Before you apply for a direct loan, make sure you can meet basic requirements. For example, you will need to have an income equal to or less than 80% of your area’s median income based on your household size.

Direct loans for single-family housing

Eligibility

To determine your eligibility for a single-family direct loan, start by checking this tool to see whether you meet requirements for your area. You can also search this USDA map to search for income limits based on your family size for both your county and state. To be eligible for a loan like this, you must also:

  • Demonstrate you are able and willing to repay your loan over time
  • Currently be without decent, safe and sanitary housing and also unable to obtain a loan you can afford from a traditional lender
  • Plan to live in the property you purchase or build
  • Be legally and mentally able to obtain a home loan
  • Be a U.S. citizen or an eligible noncitizen
  • Not have been barred from using any federal program

Property requirements

  • Property must be in a designated rural area. Use this USDA eligibility tool to determine if the address of the property where you hope to live qualifies.
  • Property must have 2,000 square feet of living area or less.
  • Property cannot exceed loan limits, which vary by county and state. You can check the loan limits in the county you want to live on the USDA website.
  • Property cannot have an in-ground swimming pool, rental units or be designed for income-producing activities.

Loan limits

USDA single-family housing direct loans come with widely varying limits, depending on where you live and the cost of housing in your area.
In Clay County, Ala., for example, the loan limit for a single-family home in this program is only $169,000. In Santa Barbara, Calif., on the other hand, USDA direct loans for single-family homes top out at $522,560.

This resource from the USDA can help you compare loan limits in areas you may want to live in.  

Direct loans for multifamily housing

Eligibility

  • These loans provide financing for qualified borrowers to help increase the supply of affordable rental housing in eligible rural areas.
  • The loans may be available for use by individuals, trusts, associations, partnerships, limited partnerships, nonprofit organizations, for-profit corporations, consumer cooperatives, most state and local government entities and federally recognized tribes.
  • You must have legal authority to build or construct a multifamily housing unit.
  • You must be able to to commit to a repayment period of 30 years or less.

Property requirements

  • The property must be in a designated rural area.
  • The property must be occupied by low-income or moderate-income families, elderly individuals ages 62 and older or disabled families or individuals. According to the USDA, very low income is anything below 50% of an area median income, while low income is 50-80% of area median income. Moderate income is capped at $5,500 above the low-income limit for any given area.  

The takeaway

Terms for USDA direct loans on single-family homes are generous. For example, the fixed interest is based on current market rates at loan approval or during closing (whichever is lower).  Also, as stated above, because the loans come with varying levels of assistance, depending on income and where you live, the effective interest rate might end up as low as 1%.

No down payment is required for these loans provided you don’t have more than $15,000 in non-retirement assets. (Note: The asset limit for elderly applicants is $20,000). This benefit makes it much easier for potential homebuyers to afford the upfront costs of moving and relocating.

Still, to get a USDA direct loan, you will be required to pay some closing costs. These costs vary widely and can include the cost of an appraisal, the cost of a credit report, 12 months of prepaid homeowners insurance premiums and additional charges required to fund your escrow account. You may be able to roll these charges into your loan amount, so be sure to check.

How to find a USDA direct loan

To apply for a USDA direct loan, you’ll need to work directly with a state office that is part of the U.S. Department of Agriculture Office of Rural Development. This USDA web page will let you browse offices by state. The USDA also offers a list of local offices organized by state.