If you’re in the market for a mortgage, you might have heard of USDA loans. These government-backed mortgages are a popular choice for people who want to buy a home in rural areas or certain suburban areas. But what exactly are USDA loans, and how do they work? In this guide, we’ll answer all your questions about USDA loans, from what they are to how to qualify and apply for one.
Government-Backed Mortgages: The Ultimate Guide to USDA Loans
What are USDA loans?
USDA loans are mortgages backed by the United States Department of Agriculture (USDA). These loans are designed to help low- to moderate-income families buy homes in rural areas or certain suburban areas. The USDA loan program was created to promote economic development in rural areas and provide affordable housing for people who might not be able to afford a traditional mortgage.
Why does Rural Development do this?
This program helps lenders work with low- and moderate-income households living in rural areas to make homeownership a reality. Providing affordable homeownership opportunities promotes prosperity, which in turn creates thriving communities and improves the quality of life in rural areas.
Source: Single Family Housing Guaranteed Loan Program
Types of USDA loans
There are two main types of USDA loans: Guaranteed and Direct loans.
Guaranteed loans
Guaranteed loans are the most common type of USDA loan. These loans are offered by private lenders, such as banks and credit unions, but are backed by the USDA. Guaranteed loans have more lenient credit requirements and do not require a down payment. However, borrowers are required to pay mortgage insurance.
What does this program do?
The Section 502 Guaranteed Loan Program assists approved lenders in providing low- and moderate-income households the opportunity to own adequate, modest, decent, safe and sanitary dwellings as their primary residence in eligible rural areas. Eligible applicants may purchase, build, rehabilitate, improve or relocate a dwelling in an eligible rural area with 100% financing. The program provides a 90% loan note guarantee to approved lenders in order to reduce the risk of extending 100% loans to eligible rural homebuyers – so no money down for those who qualify!
Applicants must:
- Meet income-eligibility (cannot exceed 115% of median household income)
- Agree to personally occupy the dwelling as their primary residence
- Be a U.S. Citizen, U.S. non-citizen national or Qualified Alien
Source: Single Family Housing Guaranteed Loan Program
Direct loans
Direct loans are offered directly by the USDA to low- and very-low-income borrowers. These loans have lower interest rates than guaranteed loans and may not require a down payment. However, they have stricter credit requirements and are only available to borrowers who cannot obtain credit elsewhere.
What does this program do?
Also known as the Section 502 Direct Loan Program, this program assists low- and very-low-income applicants obtain decent, safe and sanitary housing in eligible rural areas by providing payment assistance to increase an applicant’s repayment ability. Payment assistance is a type of subsidy that reduces the mortgage payment for a short time. The amount of assistance is determined by the adjusted family income.
Applicants must:
- Be without decent, safe and sanitary housing
- Be unable to obtain a loan from other resources on terms and conditions that can reasonably be expected to meet
- Agree to occupy the property as your primary residence
- Have the legal capacity to incur a loan obligation
- Meet citizenship or eligible noncitizen requirements
- Not be suspended or debarred from participation in federal programs
Properties financed with direct loan funds must:
- Not have market value in excess of the applicable area loan limit
- Not be designed for income producing activities
Borrowers are required to repay all or a portion of the payment subsidy received over the life of the loan when the title to the property transfers or the borrower is no longer living in the dwelling.
Source: Single Family Housing Direct Home Loans
Eligibility for USDA loans
To be eligible for a USDA loan, you must meet certain requirements:
Location
USDA loans are only available for homes located in rural areas or certain suburban areas.
As per the National Agricultural Library, ideas and definitions relating to the term rural are diverse. The Census Bureau defines rural as any population, housing, or territory not in an urban area. This definition is closely tied to its urban definition, of which there are two geographical types:
- “Urbanized Areas” have a population of 50,000 or more.
- “Urban Clusters” have a population between 2,500 and 50,000.
You can check if a home is eligible for a USDA loan by using the USDA’s eligibility map.
Income
To qualify for a USDA loan, your household income must be below a certain limit. The limit varies depending on the size of your household and the location of the home you want to buy.
For a guaranteed loan, for a family of 4, in most areas the the annual household income should be between around $33,000 and $109,000.
You can check the income limits for your area on the USDA’s website.
Credit score
While USDA loans have more lenient credit requirements than traditional mortgages, you still need a credit score of at least 640 to qualify for a USDA loan.
Employment history
You must have a stable employment history and be able to show that you have enough income to make your mortgage payments.
How to apply for a USDA loan
To apply for a USDA loan, follow these steps:
- Find a USDA-approved lender in your area.
- Gather the necessary documents, such as proof of income and employment, tax returns, and bank statements.
- Fill out the lender’s loan application and provide the necessary documentation.
- Wait for the lender to process your application and give you a pre-approval letter.
- Find a home that meets the USDA’s eligibility requirements and make an offer.
- Once your offer is accepted, work with the lender to complete the loan application process and close on the loan.
Benefits of USDA loans
There are several benefits of USDA loans, including:
No down payment
USDA loans do not require a down payment, which can be a major barrier to homeownership for many people.
Low interest rates
USDA loans have lower interest rates than traditional mortgages, which can save you thousands of dollars over the life of the loan.
Lenient credit requirements
USDA loans have more lenient credit requirements than traditional mortgages, which can make them a good option for people with less-than-perfect credit.
Mortgage insurance
While USDA loans do require mortgage insurance, the insurance rates are lower than those of other government-backed mortgages, such as FHA loans.
Closing costs
USDA loans allow sellers to pay up to 6% of the buyer’s closing costs, which can help reduce the upfront costs of buying a home.
Drawbacks of USDA loans
While USDA loans have many benefits, there are also some drawbacks to consider:
Location
USDA loans are only available for homes located in rural areas or certain suburban areas. If you’re looking to buy a home in a more urban or suburban area, a USDA loan may not be an option for you.
Income limits
To qualify for a USDA loan, your household income must be below a certain limit. If your income is above the limit, you will not be eligible for a USDA loan.
Mortgage insurance
While the mortgage insurance rates for USDA loans are lower than those of other government-backed mortgages, they can still add a significant amount to your monthly mortgage payment.
Frequently asked questions
- Can I use a USDA loan to buy a vacation home? No, USDA loans are only available for primary residences.
- Can I use a USDA loan to buy a fixer-upper? No, USDA loans are only available for move-in ready homes.
- Can I refinance my current mortgage with a USDA loan? Yes, if you currently have a USDA loan, you can refinance it with another USDA loan.
- Can I use a USDA loan to buy a condo? Yes, as long as the condo is located in an eligible area and meets the USDA’s requirements.
- How long does it take to process a USDA loan application? The processing time for a USDA loan application can vary depending on the lender and other factors, but it typically takes 30 to 45 days.
Conclusion
USDA loans are a great option for people who want to buy a home in a rural or suburban area but may not be able to afford a traditional mortgage. With no down payment, lower interest rates, and more lenient credit requirements than traditional mortgages, USDA loans can help make homeownership more accessible for many people. However, it’s important to consider the eligibility requirements and drawbacks of USDA loans before deciding if they’re the right choice for you.