As a whole, USDA mortgages are designed to “promote homeownership in underserved areas” and are reserved for low- and moderate-income earners only. They can either be issued by the U.S. Department of Agriculture or insured by it, depending on which loan program you are eligible for.
Types of USDA Loans
For buyers interested in a single-family home, there are two types of USDA loans to choose from: a direct USDA loan or a guaranteed USDA loan. Direct USDA loans are issued by the U.S. Department of Agriculture itself and are available to only low- and very-low-income borrowers. Guaranteed USDA loans are issued by an approved lender but insured by the Department of Agriculture. This alleviates much of the risk to the lender, allowing them to approve borrowers with lower credit scores, smaller down payments, and less income. Below are the main differences between the two types of loans. Finally, there are also site loans (designed for purchasing land for rural development) and USDA repair loans and grants. Repair loans and grants offer up to $27,500 in funds to remove safety and health hazards, improve a property’s accessibility, and make repairs.
USDA Loan Eligibility
The biggest eligibility requirement for a USDA loan is that the property you’re purchasing, rehabilitating, or refinancing is located in an eligible area. To find out if a property you’re considering is eligible for USDA financing, head to the Department of Agriculture’s eligibility tool, and select the loan program you intend to use. Below are the other eligibility requirements you’ll need to contend with.
Credit score: Often 640 or higher (may vary by lender, though) PITI debt-to-income ratio: 29% Total debt-to-income ratio: 41%
There may be additional eligibility requirements depending on which loan program you choose. With direct USDA loans, for example, you must be unable to find safe or sanitary housing, as well as other financing options.
Pros and Cons of USDA Loans
The biggest advantage of a USDA loan is that it requires no down payment, which makes them more affordable than FHA loans. This can be a big plus if you’re low on cash or are having trouble saving money. Some USDA borrowers may also be able to roll their closing costs into the loan balance, reducing the upfront costs of buying a house even further. On the downside, USDA loans do come with a guarantee fee, both upfront and annually. Additionally, the number of available USDA loans is limited (particularly on direct loans), and you can only apply for them with certain mortgage lenders. If funding levels for guaranteed loans are limited at the end of the fiscal year, applications are prioritized for first-time homebuyers.
USDA Loan Costs
USDA loans come with closing costs, as with any home purchase, though these vary based on your loan balance and the exact USDA program you’re using. You also may be able to finance these and roll them into your loan.
Although USDA loans don’t require mortgage insurance (like FHA loans do), they do come with guarantee fees, which you’ll pay once at closing time, then monthly, along with your mortgage payments. In some cases, you may be able to finance the upfront guarantee fee and spread it across your loan term, as well. If you’re using your USDA loan for a new construction property, then you’ll need to cover the costs of multiple “phase” inspections, too. These run at least a few hundred dollars each.
USDA Loan Costs
Upfront guarantee fee: 1% of the loan balanceAnnual guarantee fee: 0.35% of the loan balanceDown payment: $0
Refinancing With a USDA Loan
You can also use a USDA loan to refinance an existing mortgage. These are available as Direct or Guaranteed loans, and there’s even a fast-tracked, “Streamlined” version of the program you can use if you already have a USDA property. To qualify, you’ll need to be current on your mortgage loan for at least the last six to 12 months (depending on the refinance program you choose), and your new interest rate must be the same as or less than your existing one. In some cases, you may be able to finance the closing costs and upfront guarantee fee on your new loan.
The Bottom Line
If you’re interested in using a USDA loan to purchase, repair, or renovate a rural property, then contact a USDA-approved lender in your area to get started. Be sure to shop around, as interest rates and closing costs can vary greatly from one lender to the next.
