Anyone who plans to buy a new home knows that there are many different mortgage options out there. Some federal programs are especially suited to help buyers purchase a home in certain areas. One such option is the USDA loan, sponsored by the United States Department of Agriculture Rural Development office. A USDA home loan incentivizes home buyers to encourage them to move to rural areas. Learning about USDA loans can be immensely beneficial if you’re buying a farm, ranch, or in a rural area.

What is a USDA Loan?

USDA loans are part of the Rural Development Housing Guaranteed Loan program, designed to stimulate economic growth in rural and suburban areas. They are the only loan product on the market where you can buy a home without a down payment. Even better, they often offer lower mortgage rates than conventional loans. This makes them an excellent option for those who may not qualify for conventional financing.

The USDA guarantees these loans, meaning they will repay the lender if the borrower defaults.

The Purpose of USDA Loans

Launched in 1994, the primary goal of the USDA Rural Development arm was to incentivize people to move to suburban and rural parts of America. By encouraging population growth in these areas, the government aims to boost local economies. Additionally, USDA-backed loans make homeownership more accessible to low- and moderate-income households, especially in locations where mortgage lenders might not approve loans. They’re also options for first-time homebuyers who don’t meet conventional loan requirements.

Loan Program Options

A USDA Home loan is not a single loan. The types of loans under its umbrella:

• Single-family housing guaranteed loan: These are backed by the USDA, but are issued by private lenders like credit unions, mortgage brokers, and banks.
• Single-family housing direct loans: The USDA acts as the backer and the lender. Direct loans are harder to secure and are reserved for low-income borrowers.
• Multi-family housing loans: To help rural property owners develop or repair multi-family homes for low-income, elderly, and disabled individuals.
• Rural Repair and Rehabilitation Grants: Also called Section 504, this program for very low-income borrowers helps repair and improve their home to modern health and safety standards. The improvement loan maximum is $40,000.

Key Features of USDA Loans

• No Down Payment Required: One of the standout features is that USDA loans do not require a down payment, making it easier for low-income individuals to afford a home. Of course, you can make a down payment, which will give you even better loan terms.
• Low Interest Rates: USDA loans often come with competitive interest rates. What you will receive depends on current interest rates, credit scores, and negotiations with the lender. Still, their going rate can be significantly lower than those of conventional loans. The USDA caps the maximum rate based on current market rate averages from Fannie Mae.
• Mortgage Insurance Premium: While USDA loans do require mortgage insurance premiums (MIP), these rates are typically lower than those for conventional or FHA loans.

Guaranteed vs Direct Loans

The two main types of loan, the single-family guaranteed and direct, have some subtle differences in their loan requirements.

A guaranteed home loan can finance single-family, condos, manufactured housing, and other property types. Repair and renovation costs can be wrapped into the loan. Lender fees and closing costs are wrapped into the loan. However, they have a one-time guarantee fee of 1% and an annual 0.35% fee.

Direct home loans can be used for new construction, repair, or renovation. Their interest rates often are below market rates. They also have longer repayment terms to spread out the cost of homeownership.

Who Is Eligible for a USDA Loan?

Eligibility requirements vary slightly depending on guaranteed vs direct loan. However, various factors are similar, including income, credit score, and property location. Here are the key criteria:

• US Citizenship or Permanent Residency: Applicants must be United States citizens or have permanent US residency.
• Income Limits: Income weighs heavily in loan eligibility. Your income level must fall into the moderate or low end of the income range for your area. The Rural Development office defines this as less than 80% of the local median income. The combined income of the adults in the household cannot be more than 115% of the median local income. It also factors in household size. You must have a steady job with a monthly income for at least two years and be able to provide tax returns.
• Monthly Payment Limit: The loan monthly payment cannot exceed 29% of the borrower’s monthly income.
• Property Location: The home must be in a USDA-approved rural or suburban area. You won’t be able to buy a home in a city like Jacksonville or Atlanta. But there is good news. Approximately 97% of US land qualifies.
• Credit Requirements: Mortgage lenders set their minimum credit score. Generally, a FICO credit score of at least 640 is recommended. The USDA does have other methods to evaluate loan applicants’ ability to repay debt if they do not have a credit score.
• Debt-to-Income Ratio: Typically, the debt-to-income ratio should be 41% or less, though this may vary by lender.
• Primary Residence: The home must be the applicant’s primary residence. You cannot purchase an investment property or an operating farm with a USDA home loan.

Additional Features and Benefits

USDA loans come with several other attractive features:

• Fixed-Rate Loans: USDA loans require borrowers to have a fixed-rate loan, providing stability in monthly payments.
• Lower Closing Costs: Closing costs for USDA loans are often lower than those for conventional loans, making the path to homeownership more affordable.
• Direct Loans: For those who don’t qualify through traditional means, the USDA offers direct loans with interest rates as low as 1%.
• No Prepayment Penalty: If you find yourself able to pay your loan obligation early, you can do that.
• No private mortgage insurance (PMI): Other loan types that allow for no or little down payment often require the borrower to pay an additional fee.

Special Programs

• Rural Repair and Rehabilitation Grants: Available to homeowners over 62, these grants help make essential repairs to homes in rural areas.
• Mutual Self-Help Loans: These loans are aimed at individuals who cannot obtain credit from other sources. The borrower receives a very low interest rate for an extended period–1% for up to 38 years.

Downsides to a USDA Loan

Although some requirements are a little different, and you’ll have better than usual mortgage rates, you can expect a USDA loan to function much like a conventional loan. However, it does come with some limitations:

• Geographical Restrictions: You can only buy homes in USDA-approved areas These generally exclude all urban locations. The maps shift as populations change.
• Mortgage Insurance Premiums: The USDA also charges homeowner-paid mortgage insurance premiums (MIP). Still, even these rates are lower than those of a conventional or FHA loan! When you aren’t paying much for mortgage insurance on top of already lower monthly payments, owning a house is a lot less expensive.

• Housing Choices: The home must meet safety and sanitary specifications.
• Loan Limits: The direct loan funds have maximum loan limits depending on where you buy the home. Guaranteed loans are limited to 100% of the appraised value plus the guaranteed fee. Additionally, keep in mind your monthly mortgage payment cannot be more than 29% of the household income.
• Set Loan Terms: The program only works with 30-year fixed-rate loans.

How to Apply

First, eligbility requirements depend on location and adjusted income. Check the USDA maps and income limits for the area to verify you are an eligible applicant.

For a guaranteed USDA loan, you’ll submit a loan application with a USDA-approved lender. Like any conventional home loan, the mortgage lender will ask for proof of income, check your credit score and credit history, and evaluate your debts.

For the USDA Direct Loan, the loan application is submit to the local Rural Development Office. Find the office nearest to you and ask about the loan process.

Borrowing with a USDA Loan

USDA loans can be a great choice for home buyers who dream of life in a less populated area. These loans give a viable path to homeownership for low- and moderate-income individuals, stimulating economic growth in rural America.

If you meet the requirements for USDA loan eligibility, it’s definitely worth checking out. Consult with a licensed USDA-approved lender to explore how a rural development loan can benefit you. Whether you’re a first-time homebuyer or looking to move to the country, USDA loans could be your ticket to affordable homeownership.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.