Understanding USDA Home Loans
For those who would rather see a pasture than a skyscraper through their window, a USDA home loan could make buying a home a reality. The U.S. Department of Agriculture (USDA) designed the loan programs to help people afford a home, and they’re among the best mortgage offers available if you’re eligible and looking to move to a rural area.
What is a USDA loan?
The USDA offers several types of mortgage loans and grants directly to borrowers and works with lenders who offer USDA-guaranteed loans. USDA home loans are sometimes called Rural Housing or RD loans in reference to the USDA’s Rural Development department, which operates the loan programs.
The single-family USDA programs are intended to assist very low-, low- and moderate-income households looking to buy, repair or improve a primary residence. Similar to other types of government-backed mortgages, such as VA or FHA loans, USDA mortgage loans may have
requirements that are less strict than those of conventional mortgage loans. The exact income eligibility limits depend on the area and family size. (We’ll get into the specifics later.)
Additionally, single-family USDA home loans are generally only available in rural areas that have a population no greater than 35,000. Jennifer Beeston, vice president of mortgage lending at Guaranteed Rate in Sonoma County, Calif., says home buyers may be missing out by assuming USDA loans aren’t available in certain areas.
“You’re not going to find it directly in the city, but might be just a little bit out,” says Beeston. “But they are lending in areas where you wouldn’t expect,” including some high-income towns near major cities.
Three USDA loan programs may be especially interesting to individuals and families who aim to buy, repair or improve a home: USDA Direct Rural Home Loans, USDA-Guaranteed Loans and USDA Single Family Housing Repair Loans and Grants.
USDA Direct Rural Home Loans
The USDA direct loan is also known as the Section 502 Direct Loan Program, and its terms are generally quite favorable compared to other mortgage options. It’s designed for low- or very low-income applicants.
- If approved for a mortgage loan through the program, you may not have to put any money down or pay an origination fee.
- Your repayment period could be either 33 or 38 years, depending on your income. The maximum repayment term for manufactured homes is 30 years.
- The mortgage will have a fixed interest rate, but after taking payment assistance rate into account, your interest rate could be as low as 1%.
- You won’t have to pay for mortgage insurance.
To apply for a USDA home loan, you’ll have to work with a local RD office. Visit the RD’s Single Family Housing Direct Home Loans website and in the top right use the “select your location” drop-down menu to choose your state. Once you do, you’ll see new options in the right-hand column with contact information or an option to view your state program contacts. Alternatively, here’s a list with each state office’s contact information and website.
At a minimum, you must have an adjusted income that’s at or below the limit for a household of your size in your area, which is up to about 80 percent of the area’s median income. You must also demonstrate a willingness and ability to repay the loan.
You also can’t currently have “decent, safe and sanitary housing” and must be unable to get a reasonably affordable loan from another lender. Also, even within eligible areas, only some homes may qualify.
In addition to issuing loans directly to borrowers, the USDA guarantees mortgage loans from select lenders for low- and moderate-income households. With the guaranteed loan program, the USDA backs 90 percent of the total loan amount, so lenders don’t shoulder all the risk that comes with giving borrowers a loan with no down payment. You may also see these called Rural Housing or RD loans, which can be confusing.
As with the USDA direct loans, USDA-backed loans can only be used in rural areas with populations of up to 35,000. You can use the loan to either buy, rehabilitate, renovate or improve a home, or to refinance a loan on an eligible property.
But this loan program has a higher income limit than you’ll find with USDA direct loans, and you will need to pay a 1 percent upfront financing fee and 0.35 percent annual fees. (You may have the option to finance some or all of the upfront fee with the loan.) USDA-backed mortgages have a 30-year term with a fixed interest rate, and the rate can vary depending on the lender.
You can apply for USDA-guaranteed loans with an eligible lender. In addition to finding an eligible lender, Beeston says you should try to work with a loan officer who has experience with USDA loans.
USDA Single Family Housing Repair
In addition to lending money to homebuyers, the USDA has a program that allows very low-income homeowners to borrow money at favorable terms to repair, improve or modernize their home and remove health and safety hazards.
To qualify, your family income must be below 50 percent of your area’s median income, you must not be able to get an affordable loan elsewhere and you must own and live in the home. Additionally, your home must be within an eligible area (the same areas covered by other USDA loans).
The maximum amount you can borrow through the program is $20,000. The loan will have a 20-year repayment term and fixed 1% interest rate.
Applicants who are at least 62 years old and need money to pay for repairs or remove health and safety hazards may be eligible for up to an additional $7,500 as a grant. If you can afford to repay some, but not all, of the money you need, you could be offered a combination of a loan and a grant. You don’t have to repay a grant unless you sell your home within three years.
As with the USDA direct loans, you should contact a local your local Rural Development field office.
Hidden costs of USDA loans
While the USDA home loans are designed so very low- to moderate-income households can afford to buy a home, there are some expenses to look for when considering these loans.
- Closing costs. There may be closing costs associated with getting the mortgage, but you may be able to finance some of these within the mortgage or negotiate to have the seller cover some of them.
- Down payment. While USDA loan programs may help you get a home without a down payment, you may have to contribute toward a down payment, or costs associated with the purchase if you have more than $15,000 in non-retirement assets. For elderly applicants, the non-retirement asset limit is $20,000.
- Upfront and annual fees. USDA-guaranteed loans have a 1 percent upfront fee and 0.35 percent annual fee.
- Subsidy recapture. If your direct loan’s interest rate or mortgage payments were subsidized, you might have to repay the subsidy when you move, transfer the home to someone else, sell the home or pay off the loan (including if you refinance the mortgage).
However, you may not need to pay back the entire subsidy amount. If you repay it when the loan is paid off, you only need to repay 75 percent of the subsidy. You can also reduce the subsidy recapture amount by making capital improvements to the home, such as adding a room or building a deck.
How to qualify for a USDA direct loan
Qualifying for USDA loans, guaranteed loans and repair loans may not be easy. Two basic requirements are the home’s location and the household’s income. Beeston, the vice president of mortgage lending at Guaranteed Rate, suggests using the online eligibility tool, as it can take just a few minutes to check if you meet both the requirements.
Start by choosing the loan program and entering the home’s address. If you don’t have specific property in mind yet, use an address in an area you’re interested in to see if it’s an eligible area.
You can then also check the income eligibility, which can vary depending on the loan type, state, county and your household size. Beeston says, “I see people trip up a lot on this, because your income goes up based on how many people live in the house, even if they’re not on the loan.” However, each resident who is under 18, a full-time student or disabled, will deduct $480 from the household’s income.
- Very low-income requirements are about 50 percent of the median income for the area.
- Low-income requirements are about 80 percent of the median income for the area.
- Moderate-income requirements are about 80 percent of the median income for the area plus $5,500.
In addition to the location and income requirements, there are other applicant and property requirements you’ll need to meet to get the loan.
Applicant requirements for USDA loans
- You must purchase and use the home as your primary residence.
- You can’t qualify for a reasonable loan from a different lender.
- Your credit score must be at least 640, and even if your score is above that, you may not qualify based on your credit history. For example, if you had a foreclosure, bankruptcy, debt settlement or short sale within the last 36 months, you may not get approved. If you can’t qualify on your own, you may be able to apply with a cosigner.
- You have the means to make your mortgage payment. This could prevent you from qualifying if you don’t have any income.
- You must be a citizen or eligible noncitizen.
- You can’t be suspended or debarred from federal programs and must be legally capable of to take out a loan.
The direct loan program also requires applicants to:
- Not currently have a decent, safe and sanitary place to live.
- Not own another home, unless that home isn’t decent, safe and sanitary, or is too small for the household.
Property requirements for USDA loans:
- The property must have a market value below the area’s loan limit.
- It must be a modest home. Generally, this means the house is 2,000 square feet or smaller (not including a basement or attached garage).
- It can’t have an in-ground pool.
- It can’t be designed to produce income (e.g. have an attached rental unit).
Alternatives to USDA direct loans
Although a USDA direct loan may be a great option for some homebuyers, there are alternative mortgage loan options to consider. Some are government-backed, or you may be able to qualify for a conventional loan.
|Alternatives at a Glance|
|USDA direct loan||USDA-backed loan||FHA loan||VA loan||Conventional conforming loan|
|General qualification criteria||Area-based very low- to low-income limits and home eligibility requirements.||Area-based low- to moderate-income limits and home eligibility requirements.||Relatively low credit score, debt-to-income ratio and down payment requirements.||Be an active-duty or retired member of the armed forces, or widow of a service member who died in the line of duty.||Good credit, low debt-to-income ratio and enough money for at least five percent down, but ideally 20 percent down.|
|Minimum credit score||640||640||580 (500 with a 10 percent down payment)||None, but some lenders require 620||620|
|Minimum down payment||0 percent||0 percent||3.5 percent||0 percent||5 percent|
|Maximum loan amount for a single-family home||No pre-set maximum — it depends on the area, home’s value and additional loan costs.||No pre-set maximum — it depends on the area, home’s value and additional loan costs.||The lower of 115 percent of the HUD-determined median home price or $424,100.
$636,150 in high-cost areas.
$954,225 in parts of Alaska, Hawaii, Guam and the Virgin Islands
|No pre-set maximum, but you may need to make a down payment if the home costs more than the conforming loan limits.||$424,100 in many areas.
$636,150 in high-cost areas.
$954,225 in parts of Alaska, Hawaii, Guam and the Virgin Islands
|Mortgage insurance||Not required||Not required, but there’s an upfront funding fee and annual fee.||Yes, plus an upfront premium payment||Not required, but there’s a lending fee||Required with down payment below 20 percent|
|Pros||No down payment or mortgage insurance, and you can get subsidized interest payments.||You may be able to buy a home with no money down.||Low credit score, debt-to-income ratio and down payment requirement||It’s easy to qualify for a loan and you don’t need a lot of money to buy a home.||If you’re eligible, the lending process can be more straightforward than it is with government loan programs.|
|Cons||Must meet income and location eligibility requirements.||Must meet income and location eligibility requirements.||You can’t cancel the mortgage insurance on an FHA loan unless you refinance.||You’ll have to pay a funding fee.||Only available if you have good to excellent credit.|
|Best for||Very low- to low-income applicant buying a home in a rural area.||Low- to moderate-income borrowers who want to buy in a rural area.||Those with low credit score or not enough money for a large down payment.||Eligible applicants who can’t qualify for a conventional loan, or who determine that the VA loan fees are more than offset by avoiding a down payment and mortgage insurance.||People with money for a down payment, a good credit score and a low debt-to-income ratio.|
FHA loans. As with USDA-guaranteed loans, the Federal Housing Authority (FHA) doesn’t lend money directly, it insures mortgages from approved lenders. FHA loans are relatively easy to qualify for and don’t limit where you can buy a home. You can also get a home with as little as 3.5 percent down if your credit score is 580 or higher.
VA loans. The Department of Veterans Affairs partially guarantees VA loans, which lenders offer to active-duty or retired member of the armed forces and widows of a service member who died in the line of duty or due to a disability related to their service. VA loans don’t require a down payment or mortgage insurance, but there is a one-time funding fee which can range from 1.25 percent to 2.15 percent, depending on how much you put down.
Conventional loans. Mortgage lenders offer conventional mortgage loans directly to consumers without any government guarantees. These are the “standard” mortgages. It may be easier to go through the conventional loan process than to apply for and get a government-guaranteed mortgage, but conventional loans tend to have higher requirements for applicants’ credit, income and down payment.