What is a USDA loan?
USDA loans are government-backed mortgages that help low- and moderate-income borrowers in rural and suburban parts of the country become homeowners.
When it comes to government loan programs, USDA is the new kid on the block. Whereas the FHA and VA programs have been around for decades, USDA loans only came into being in 1994.
But new doesn't mean untested. USDA loans are a great choice for many people who want to become homeowners but don't have money to put down.
Why should I consider a USDA loan?
There's a lot to like about USDA mortgages:
Infographic (c) Home.com. Reproduce only with permission.
USDA lenders can also use a lower percentage of your student loan balance when calculating your debt-to-income ratio than some other programs. That can make it easier to buy a home, even if you're still paying down student debt.
Two types of USDA mortgage loans
There are two types of USDA rural housing loans:
- USDA Single-Family Housing Guaranteed Loan
- USDA Single-Family Housing Direct Loan
The Single-Family Housing Direct Loan is designed for very low- and low-income borrowers, defined as being at 50-80% of the area median income. The government lends USDA Direct Loans, so you can't get them through private lenders.
For the purposes of this article, we'll be talking about the Single-Family Housing Guaranteed Loan, which is for low- and moderate-income borrowers. These are available through private lenders, so you don't need to apply through the government.
USDA loan requirements
You may be eligible for a USDA loan if you are:
- A U.S. citizen
- A permanent resident
- A foreign national
- Unable to qualify for a conventional mortgage
The borrowing criteria for a USDA loan are similar to other mortgage programs. You need to meet certain credit score, income, and debt-to-income requirements to qualify.
But the two biggest factors are:
- That you're buying in a qualifying location
- You meet the income limits for a USDA loan
Let's take a closer look at what these mean.
Remember, the USDA is in the business of rural development. So it only backs loans in areas that may need a boost in home ownership opportunities.
You're not limited to buying in a rural area, though. You can get a USDA rural home loan in both rural or suburban areas, as long as they fall into one of these categories:
- Population of 10,000 or less in areas that are in open country or are rural in character
- Population of 20,000 or less and not located in a Metropolitan Statistical Area (MSA)
- Area severely lacks mortgage opportunities for low- and moderate-income borrowers
Think those criteria disqualify you because you want to buy near a city? You'll be surprised to learn that 97% of the U.S. land mass qualifies for USDA loans, representing about 34% of the US population.
And, fortunately, USDA has put together an interactive eligibility map to take the guesswork out of finding an eligible property. Type in an address of a home you're interested in, or simply zoom in to your area.
WHAT DOES "RURAL IN CHARACTER" MEAN?
The term "rural in character" generally refers to areas where the population density is 1,000 people or less per square mile.
However, the USDA calculates population density based on local circumstances, so don't Google your town and count yourself out if it seems over the limit.
The USDA factors in things like economic hardships or local university populations to calculate the true population density. The agency also approves loans in some areas with populations up to 35,000, or that are part of an MSA, if the city is considered rural in character and it's difficult for low- and moderate-income residents to get mortgages there.
Bottom line: It's worth checking to see if your desired home is in a USDA-eligible area.
USDA mortgages are meant to give low- and moderate-income borrowers a shot at homeownership. So unlike other loan programs, USDA loans have income limits, or caps on the amount of income a borrower can earn.
The way lenders calculate borrower income for a USDA loan is also unique.
Most loan programs use only the borrower's income to qualify them for a loan. If a married couple applies for a non-USDA mortgage together, the lender looks at both their incomes. But if only one of them applies, because one has a higher credit score, the lender will use just the borrowing spouse's information.
With a USDA loan, lenders look at three numbers to determine income eligibility:
- The borrower's income to determine repayment ability (Qualifying income)
- Total household income to determine eligibility - including dependent children who earn an income (Eligibility income)
- Adjusted income after deductions (Adjusted eligibility income)
Let's break down what that means.
Infographic (c) Home.com. Reproduce only with permission.
The borrower will submit their income as proof that they can afford their monthly mortgage payments.
This is similar to the process of qualifying for any other mortgage. The lender will examine your current debt payments and future home payment versus income.
To determine if a borrower meets USDA income limits, lenders look at ALL household income. If a borrower lives with her spouse, her sister, and her 18-year-old son, and each of those people has a job, the lender will add up all of those incomes to see if the household is eligible.
That's because USDA income limits consider the median household income in an area, not just the borrower's income.
ADJUSTED ELIGIBILITY INCOME
The final puzzle piece is the adjusted income. USDA allows lenders to deduct these expenses from some borrowers' household incomes:
- $480 per minor child or disabled adult who is a non-borrower or co-borrower and is not the borrower's spouse
- 100% of childcare expenses
- $400 for either a borrower or co-borrower 62 years and older (only one deduction per loan)
- Medical expenses that are more than 3% of the household income, if the borrower is elderly or expenses are related to a household member's disability
The lender subtracts any relevant expenses from the household income to determine whether the borrower meets the local income limits.
Because income limits are linked to geography, your eligibility might change based on where you buy. If you and your spouse want to buy a house near Oklahoma City using a USDA Guaranteed Loan, your income limit is $91,900. But buy near Irvine, Calif., and the limit jumps to $156,250.
Wondering whether your household meets USDA income limits? Check out the USDA's list of income requirements by county. Here's a hint: Click your state in the map to be taken to the relevant list, rather than scrolling through all of those pages.
And if you think you have some deductions, or are right on the line, use USDA's income eligibility calculator. And, contact a USDA lender. A knowledgeable professional may be able to find additional deductions to get your income into "eligible" status.
I'M ABOVE THE INCOME LIMIT BUT I DON'T HAVE MONEY FOR A DOWN PAYMENT. CAN I STILL GET A USDA LOAN?
Unfortunately, you can't get a USDA loan if you're above the income limit.
But don't give up. If you're just over, look for additional deductions. If you're way over, you may qualify for a 0% down VA loan or an FHA loan with 3.5% down. Many lenders offer conventional loans with 3% down as well. None of these programs come with income limits.
The USDA only allows 30-year, fixed-rate mortgages. If you were hoping for a 15-year or adjustable rate mortgage (ARM), you'll need to look at a different loan program.
You can also take out a USDA mortgage now and refinance in a few years to the terms you want. But remember that you may have to pay an origination fee and closing costs on the refinance loan.
Borrowers typically need a minimum 620 credit score to qualify for a USDA loan. We say "typically" because the USDA doesn't set minimum credit score guidelines. They leave credit score requirements up to the lenders - and lenders usually want a minimum score of 620.
However, some may offer more flexibility in their criteria. Lenders will also look at your credit history, including on-time payments and whether you've had any delinquencies or defaults. If you have, they may ask for a letter of explanation about why those happened and why they're unlikely to occur with your mortgage payment.
It's always a good idea to request quotes from several lenders, to make sure you're getting the best deal on your mortgage.
If you have a low credit score, applying with several lenders may also help your chances of qualifying. One may turn down your application, but the next may offer you a loan.
This may be the biggest advantage to a USDA rural home loan: you do not need a down payment. You can buy a house with 100% financing.
Even better, you can use gift funds to cover your closing costs.
One little-known rule about USDA is that you can finance the closing costs if the appraised value is higher than the purchase price.
For instance, the home is selling for $300,000, but the appraiser says it's worth $305,000. USDA allows you to take a loan for $305,000 as long as you use the amount above the purchase price for closing costs.
You may get the keys to your own home with little to no money upfront.
Debt-to-income ratio (DTI)
Your debt-to-income ratio is your total monthly debts - mortgage included - divided by your gross monthly income.
Lenders calculate your DTI by adding up all of your debts and dividing them by your income. Generally speaking, you'll need a DTI of 41% or less to qualify for a USDA loan, unless you get an approval from USDA's computerized underwriting system (more on that later).
Here's an example DTI calculation for a borrower in Pennsylvania buying a $250,000 house with a 0% down USDA loan.
|Gross Monthly Income||$4,000|
|Mortgage principal and interest||$1,082|
|USDA mortgage insurance||$74|
|Credit card bill||$75|
|Total monthly debt||$1,812|
This borrower's DTI is 45% ($1,812/$4,000=0.45). If he pays off his medical and credit card debt, he'll be at about 41%, which is within the stated limits for USDA loans..
Alternatively, he can look for a less costly house. A lower sale price will mean less interest and mortgage insurance, which could get his DTI lower
"GUS" (GUARANTEED UNDERWRITING SYSTEM)
If you're over the DTI limit, you have a friend called GUS.
GUS is USDA's computerized underwriting system ("guaranteed" refers to the fact that these loans are backed by the government, not that you are guaranteed to be approved).
Lenders may approve you with a DTI higher than 41% if you receive a GUS "Accept" recommendation. Typically, if you have exceptional credit, cash savings, additional assets, or other compensating factors, you can get GUS-approved, even above the stated DTI limits.
So don't skip applying for USDA because you have a high DTI. You don't know if you'll be approved until the lender runs your scenario through GUS.
WHAT ABOUT STUDENT LOAN DEBT?
If you're carrying high-balance student debt, you may be worried about how it affects your DTI - and your homebuying prospects. Fortunately, USDA loans calculate student loans a little more favorably than some other loan programs.
USDA guidelines allow lenders to use .5% of your total student loan balance or the payment on your monthly statement, whichever is higher. Other programs, such as FHA, use the greater of 1% of the total balance or your monthly payment.
USDA loan limits
The USDA does not set loan limits for its Guaranteed Loan program. That means the government doesn't cap the purchase price eligible for USDA loans.
However, there will be a natural limit to how much you can borrow. Since USDA loans do have income limits, lenders will only approve you for an amount they believe you can afford. If you earn $50,000 a year, they're going to math out what a reasonable monthly mortgage payment looks like based on your earnings.
USDA's property requirements also limit you to buying a home of no more than 2,000 square feet, and it must be a modest residential property. So if you're looking for something more upscale, you'll need to consider another type of mortgage.
The USDA began setting loan limits for its Direct Loan program this year. These limits do not affect the type of USDA loans most people get - called "Guaranteed Loans." For Direct Loans, limits vary by county, though in most areas, USDA Direct Loans are capped at $285,000. Limits are significantly higher in costly areas such as Los Angeles and Sonoma counties.
In addition to being located in an eligible rural or suburban area, your house must also meet certain property requirements to qualify for a USDA rural home loan.
Most of these are common sense and similar to what you'll find with other loan programs: safe structure, adequate access to water and wastewater systems, functioning plumbing and electricity.
But there are a few requirements specific to USDA loans:
- Home must be modest and residential in character
- Minimum of 400 square feet
- Maximum square footage is 2,000 square feet
- Acreage is not large enough to be subdivided or for commercial use
The home must also pass an appraisal. If an appraiser identifies any problems that conflict with USDA property guidelines, it could stop the purchase from going through.You'll have 15 days to address the issues. You can negotiate with the seller on price if you're willing to cover the repairs after you've purchased the home. Or the seller may agree to make the fixes before the loan closes.
If the seller makes the repairs, you'll need to check them out yourself and sign a statement saying you accept the work that was done. If the repairs are unsatisfactory, you'll need to negotiate again until the seller accepts the requirements.
What types of properties can you buy with a USDA home loan?
List property types:
- Single-family homes
- Land for new construction
INVESTMENT PROPERTIES, SECOND HOMES, INCOME-PRODUCING PROPERTIES
There is one restriction on property types, though: You can't use a USDA loan - or any government-backed mortgage, for that matter - to buy an investment property.
So, a USDA loan for a mobile home or new construction is OK. But USDA farm loans for income-producing plots of land? Those are off the table. And although you can get a USDA construction loan, you may have a hard time finding one. Many lenders only offer USDA loans to purchase existing homes.
USDA loans cannot be used to buy a vacation home, either, even if it's in an eligible area. Whatever home you buy with a USDA loan must be your primary residence.
A quick note on buying a condo with a USDA loan. You can do it, but the condo must meet the requirements of at least one other loan program, including Fannie Mae, Freddie Mac, the VA, or the Department of Housing and Urban Development (HUD).
HUD backs FHA loans, so a quick way to find out whether your condo qualifies for USDA is to search HUD's database of FHA-approved condos.
If you're buying a manufactured home, it must be on a foundation and must meet the square footage requirements. USDA loans may be used for both single-wide and double-wide mobile homes, though most lenders will only approve loans for double-wides.
The house I want doesn't qualify for USDA, but I can't afford a down payment. What do I do?
USDA isn't the only low down payment loan program out there. Although there are only a couple of 100% financing mortgages, you can get a loan with much less than the traditional 20% down payment.
COMPARE LOW DOWN PAYMENT LOANS
|Minimum down payment||0%||3.5%||0%||3%|
VA loans also offer a 100% financing option. You can qualify for an FHA loan with as little as 3.5% down, and many conventional mortgages allow 3% down these days.
And don't forget about down payment assistance. Even if you don't qualify for 0% down USDA or VA loans, you may be eligible for a grant or forgivable loan to help cover your down payment and closing costs.
Down payment assistance programs vary by state, and some are listed on the HUD website. You can also find them at the county and city levels. Make sure to ask your lender about any local assistance programs that can get you over the finish line and into a home.
Googling "down payment assistance programs in X city" can also jumpstart your search.
USDA loan rates
USDA loan mortgage rates tend to be similar to those for VA loans - which is to say lower than those for FHA and conventional mortgages. Between lower interest rates and lower mortgage insurance rates, the overall cost of a USDA loan can be significantly less than FHA loans.
The low costs, combined with 100% financing, make USDA loans among the most affordable homeownership options for low- and moderate-income families.
The USDA loan process: How do I apply, get approved, and close on the house?
Applying for a USDA loan is a bit different than other loan types. Many of the steps are the same, but there are a couple of unique rules worth noting.
Here's how to apply:
- Review your finances. Check your credit score and review your monthly budget and debts. If your score is low or money is tight, you may want to pay down some debt before you apply. But if your credit is good and your monthly obligations are minimal, go ahead and start applying for a loan.
- Get prequalified with a USDA-approved lender. A prequalification estimates how much you may be able to borrow. It's not a guarantee - the lender will verify your financial information before they make a final decision. But a prequalification letter helps you search for homes within your budget, and it tells sellers and real estate agents that you'll likely be able to buy. Choose a lender who has experience with USDA loans so you can trust that they understand the USDA loan process and that they'll close your loan on time.
- Look for USDA-eligible properties. Once you find a property you love, look it up on the USDA eligibility map. If your real estate agent is familiar with USDA loans, ask them to only show you listings that are USDA eligible.
- Submit an offer. Here's where it helps to work with a lender and a real estate agent who are well-versed in USDA loans. They can help you craft a strong offer and provide guidance on getting the seller and their agent to accept it.
- Schedule an appraisal and inspection. Your lender will schedule an appraisal, and you're responsible for the inspection. Check with your real estate agent about whether you can waive the pest inspection (and save a little money!).
- Provide additional verification to underwriting. Your lender may need additional documents from you at this point - employment records, bank statements, tax forms. Whatever they ask for, respond as quickly as possible so you don't jeopardize your closing timeline.
- Wait for USDA approval. Besides needing to find a USDA-eligible property and needing to schedule an inspection, the USDA must also sign off on every home loan it backs. You can see when your loan will be reviewed by checking the USDA's rural development site. Under "Loan Status," you'll see a notice on which batch of applications they're currently reviewing. It's not an exact measure, but it'll give you an idea of whether your application is in the current queue.
- Schedule closing and funding dates. Work with your lender to schedule your closing date - when you'll sign your loan documents. The lender will also be able to give you a funding date, which is about two days after closing. The funding date is when the money is transferred, and you officially become the owner of the home.
- Enjoy your new home! Now comes the fun part - settling into the home and making it your own.
The USDA loan application process can take a little longer because of the USDA approval step and the time it may take to find an eligible home. Budgeting for those in your homebuying journey will help you set realistic expectations for how quickly you'll be able to get into a home.
How much does a USDA loan cost?
In terms of cash needed upfront, a USDA loan is one of the most accessible programs around.
As with any mortgage, USDA loans involve closing costs. These include origination and appraisal fees, title insurance, prepaid taxes, insurance costs, and other fees. Closing costs are typically 2-5% of the total loan.
On a $200,000 loan with zero down, closing costs can range from $4,000-$10,000. But you don't have to pay closing costs upfront.
USDA allows you to roll those costs into your mortgage if the appraised value comes in higher than the purchase price. You can also use gift funds or down payment assistance for closing costs.
USDA loans also include mortgage insurance. But here again, there's good news. The USDA mortgage insurance rate is an annual fee of 0.35%, which also gets rolled into the loan.
That's significantly less than the typical FHA mortgage insurance premium rate of 0.85% per year.
USDA VS. FHA MORTGAGE COST
Here's how a borrower's costs may change based on which loan she uses to buy a $200,000 home in North Carolina.
With the USDA loan, she would put down 0%. But with FHA, she would put down 3.5%.
This is how her monthly costs may compare.
|Principal and interest||$859||$835|
The borrower's monthly principal and interest payments are actually lower with the FHA loan. But she'll pay less overall each month because of the difference in mortgage insurance payments.
I'm a first-time homebuyer. Should I get a USDA loan?
Quite possibly! A USDA mortgage can be a great first-time homebuyer loan because you don't need a down payment and you can roll your closing costs into the loan. The lower mortgage insurance rate can also make the USDA loan program more affordable than some other mortgages.
But if you have good credit and you've saved even a small down payment, you may want to consider an FHA loan or conventional mortgage. Although you'll have to put some money down, you won't have to worry about geographic or income restrictions. And if you're a veteran, you may qualify for a 0% down VA loan with no income limits and no mortgage insurance.
A USDA loan is best for people with low or modest incomes who can afford a monthly mortgage payment but aren't able to save up a down payment.
Can I get a USDA loan if I'm not a first-time buyer? What if I own a home already?
Yes, you can get a USDA loan even if you're not a first-time homebuyer.
If you already own a home, you can use a USDA mortgage to buy another property, as long as you meet certain criteria:
You didn't use a USDA loan to buy your current home
The new home will be your primary residence
You have enough income and assets to afford both homes
Your current home is no longer adequate for your family's needs
So if you own a home right now but you're moving for a new job, moving out because of a divorce, or need more space for a new baby, you may qualify for a USDA loan even though you already own the home.
Pros and cons of a USDA home loan
USDA loans are affordable options for many families and would-be homeowners. But every loan program has some downsides, so consider whether USDA is right for your situation.
|0% down payment||Properties must be in an eligible area|
|Can use gift funds for closing costs, or roll
closing costs into the loan in some cases
|Must meet income limits (115% or less of median income for the area)|
|Lower interest rates and mortgage insurance rates than FHA and conventional loans||Owe mortgage insurance for life of the loan|
If you're feeling stumped about whether USDA is the way to go, talking to a lender or real estate agent can help. A lender can prequalify you and explain which loan programs - USDA or otherwise - may be a fit.
An experienced real estate agent can refer you to lenders who work with people in similar circumstances to yours, and they can also help you through the home search process if you choose a program like USDA, which has special requirements.
USDA Streamlined Assist Refinance Loan
The USDA Streamlined Assist Refinance Loan lets you refinance your current USDA mortgage to a more affordable payment. If you have a USDA loan and have made 12 consecutive on-time payments, you may be able to refinance to a lower interest rate.
There are no minimum equity requirements on a USDA Streamlined Assist Refinance Loan, meaning you can have no equity or even negative equity in the home.
You may be eligible if:
You've made 12 consecutive, on-time mortgage payments
Refinancing would lower your monthly mortgage payment by $50 or more
Lenders do not need to run a credit check (though some might) or assess your DTI for a USDA refinance, and you won't have to schedule another inspection. If you have a Guaranteed Loan, you won't need an appraisal either. However, local income limits still apply.