WHAT ARE USDA LOANS?
USDA loans are low-interest mortgage and home improvements loans that low-income rural and suburban homebuyers can obtain with no down payment.
These single-family home loans, issued by the US Department of Agriculture (USDA), are intended to assist buyers with less-than-average incomes and lower credit scores in their purchase of homes. These loans are designed to encourage the sale of properties with lower values than those in their local market. A USDA loan can help you buy a home in rural or suburban areas, even though there is a hot housing market.
USDA loans are mortgage loans that make it more affordable to purchase a home in rural areas. The US Department of Agriculture backs USDA loans in the same manner that the Department of Veterans Affairs supports VA loans for veterans and their family members.
Mortgage lenders can offer lower interest rates than conventional loans because they have government backing. You can purchase a home without putting down any money, provided you meet specific criteria. However, closing costs will still be payable.
HOW DOES A USDA LOAN WORK?
USDA’s Rural Development Guaranteed Loan Program provides loans to low- and moderate-income homeowners to purchase homes. To be eligible, applicants must plan to finance a rural or suburban home. The home must be used as their primary residence; the income must not exceed certain limits, while the local median income determines these limits.
The program excludes densely populated areas in the country, but this leaves 97% of the US eligible for USDA home finance.
A USDA loan allows buyers to finance 100% of the purchase price and get better-than-average mortgage rates. USDA mortgage rates are lower than other low-down payments loans. USDA loans are not uncommon.
The repayment schedule does not include a “balloon” or any other non-standard cost; closing costs are expected, and prepayment penalties are never applied.
A USDA loan does not require you to make a down payment. Zero-down financing is available through this loan program. You must take a fixed-rate loan through the USDA loan program as the program does not offer adjustable-rate mortgages. Both first-time and repeat homebuyers can use rural loans. Additionally, the USDA program does not require homeowner counseling.
TYPES OF USDA LOANS:
- Section 502 Direct Loans:
Direct USDA mortgage loan is available for low- and very low-income borrowers. The loan proceeds can be used to buy, renovate, relocate, or improve a property, including installing water and sewer services.
For those who cannot afford the monthly payments for a 33-year loan, there are 38-year loans available. Section 502 loans can only be used to finance a home that meets specific criteria, such as cost. Section 502 loans are subject to a price limit in each county because home values can vary by region.
Here are the steps to get a USDA direct loan:
- Down payment: 0.13%
- The debt-to-income ratio: The DTI should be 41% unless compensating factors are present such as a history that allows you to comfortably spend a more significant percentage of your income on housing.
- Credit score: At least 640. You may still be eligible even if your score falls below 640 or you do not have one. If you have no delinquent credit reports or can provide non-traditional credit such as rental history, you will be able to make a stronger case.
- Income limit: Between low and very low income. Limits vary by country and household size.
- Location of property: The area must have less than 35,000 residents, which applies to all places, not just rural.
- Property Type: Primary residence, non-income-producing. The property cannot have an above-ground swimming pool.
- Size of the home: Less than 2,000 square feet
- Property size: According to local zoning laws, it should be small enough not to be divided into smaller parcels.
- Single-Family Housing Repair Loans & Grants:
This USDA initiative, also known as Section 504 Home Repair Program (or simply the USDA Initiative), lends money to homeowners who want to fix or upgrade their homes. The program is open to those whose incomes are below 50% of the local median income. It is helpful to finance improvements to their homes (no vacation or rental properties).
Single-family Housing Repair Loans provide financing up to $20,000 with a fixed interest rate of 1%. The maximum period for repayment of the loan is 20 years.
Single-family housing repair grants allow applicants over the age of 62 to receive up to $7,500 for projects that improve their home’s safety. Although individuals can apply for multiple assignments at once, the maximum lifetime grant amount is $7,500. The grant requires to be repaid if the property is not sold within three years.
USDA Guaranteed Loans:
USDA Guaranteed Loans, which are not issued directly by the USDA, can be administered through USDA-approved lenders, including banks and credit unions. Lenders can be assured that the Guaranteed Loan program will cover 90% of all loans issued under its guidelines. Lenders can offer low-interest loans to borrowers with less than perfect credit scores who do not have to make a down payment. If the buyer does not put down any money, they will have to pay a mortgage insurance fee known as a guarantee fee.
It is the type of loan that can only be obtained through a USDA-approved lender. Here are the steps to qualify for USDA Guaranteed Loan:
- Down payment: 0%
- Assets: None
- The ratio of debt-to-income: The DTI should be 41%. You may still be eligible if you have a history of paying more than 41% of your income in debt payments while still meeting your financial obligations.
- Credit Score: You do not need to have a minimum credit score. However, it is possible to be still eligible if you have a lower score or no score. If you have no delinquent credit reports or can show a history of paying rent on time or other positive sources of credit, you will be able to make a stronger case.
- Income: Not exceeding 115% of the median income in the area. You cannot qualify for conventional financing without private Mortgage Insurance (PMI), a one-year history in traditional employment or two years of self-employment, or seasonal income.
- Location of property: Must have less than 35,000 residents. It applies to all areas, not just those in rural areas.
- Property Type: Primary residence, non-income-producing. The property cannot have an in-ground swimming pool.
- Size of the home: It must be small for the area.
- Size of the property: It must be in line with the local norms
DIFFERENCE ENTIRELY BETWEEN USDA & CONVENTIONAL LOANS:
USDA mortgage rates are among the lowest compared to other loan programs.
The VA loan is only for veterans, and the USDA loan rate is the only program to match the rates of VA loans. Because of their government guarantee, these two programs (VA and USDA) can offer interest rates below market because they protect lenders from loss.
Other mortgage programs like the FHA loan or conventional loan can have 0.5% to 0.75% higher than USDA rates. Mortgage rates differ individually.
It would be best to have a good credit rating and a low debt-to-income ratio to get the lowest rate and monthly payment. A larger down payment is also a good idea.
Also, it would be best if you shopped around with several USDA mortgage lenders. Every USDA lender sets rates differently, so it is crucial to compare rates from multiple companies to get the best rate. Payment is through the way of equal monthly installments with interest.
USDA loans are not the same as other government-backed loans. Here’s how:
- Deposit Payment: Many people struggle to develop the cash needed to close on a house, including your down payment and closing expenses. You can get a conventional loan without having to pay 20% down. There are two types of loans that offer zero-down financing for eligible: VA loans and USDA loans. A USDA loan might be an option if you do not fit the VA’s military service requirements.
- Guarantee Fee: The guarantee fee, also known as the funding fee, enables 20% down payments to be made. Consider your down payment to be upfront mortgage insurance. Private mortgage insurance is not required if you have a conventional loan with more than 20% down. Mortgage insurance covers a lower down payment, adding to your monthly mortgage payment until your loan balance has been paid off. Mortgage insurance is required for USDA loans. This money goes towards funding the USDA loan program. Because it is capped at 1%, it will probably cost you less than the PMI for a conventional loan.
THE APPRAISAL PROCESS FOR USDA LOANS:
Although both USDA and conventional loans require appraisals by an independent third party before approval, they serve slightly different purposes. The assessment is required for conventional loans. It ensures that the loan amount is reasonable concerning the property’s actual value. A conventional lender will not give you a loan amount that is greater than the property’s value. They can’t recover their losses from the sale price of the actual property. A home inspector is hired to provide a report about the condition of your home and any potential problems, such as the roof or appliances. All these are the things that an appraisal does for a USDA loan:
- It is similar to an assessment for conventional loans.
- It ensures that the home meets USDA standards. The home must be in an essential livable condition to qualify, it must be in good working order, including heating and roof systems, it must not have broken windows. The appraiser will inspect for insect damage and verify that the well- and septic systems comply with USDA guidelines. A home inspector is still a good option if you need a detailed report on your buying property.
MORTGAGE INSURANCE MI (MI) FOR USDA LOANS:
USDA guarantees its mortgage loans, meaning that it protects mortgage lenders in the event of default by USDA borrowers. The program is partly self-funded. The USDA charges homeowners mortgage insurance premiums to keep the loan program running. USDA has reduced its monthly and upfront mortgage insurance fees as of October 1, 2016.
Current USDA mortgage insurance rates:
- Purchases: 1.00% upfront fee based on loan amount
- Refinance: 1.00% upfront fee based on loan amount
- All loans: 0.35% annual fee based on the principal balance.
USDA upfront mortgage insurance cannot be paid in cash. You are required to pay it in installments, and it is added to your loan amount.
USDA mortgage insurance rates can be lower than conventional or FHA loans. FHA mortgage insurance premiums are 1.75% upfront and 0.85% annually. Premiums for conventional loan private mortgage insurance (PMI) can vary but are often higher than 1% annually.
Mortgage insurance premiums for USDA-guaranteed loans are only a fraction of what you would typically pay. USDA mortgage rates are also low.
USDA mortgage rates are typically the lowest of FHA, VA, and conventional mortgage rates. It is especially true if buyers have a low down payment amount. USDA mortgage rates are 100 basis points (1.00%) lower than conventional loans for buyers with average credit scores. USDA loans are incredibly affordable because they have lower rates, meaning that you will pay less each month in mortgage payments.
USDA home loans are based on the median income in your area. You cannot earn more than the area median income to be eligible for a USDA loan.
MINIMUM DOWN PAYMENT FOR THE USDA LOAN:
USDA loans do not require a down payment. A USDA loan is used to finance 100% of your home’s price. If you decide to make a down payment, you can lower your monthly mortgage and possibly afford a larger home.
HOW TO QUALIFY FOR A USDA LOAN
The following requirements are required to be met in order to be eligible for a USDA Loan:
- Residency: You must be a US citizen, non-citizen, or Qualified Alien.
- Localization: A USDA loan can only be used to finance homes in eligible rural areas or suburbs.
- Income: USDA loans are available to families that demonstrate economic need. Your adjusted gross income must not exceed 115% of the area’s median income. You must also prove that you have a steady income and can afford your mortgage payments for at least 12 consecutive months, based on your current income, assets, and savings. When deciding whether to approve you for a USDA loan, your mortgage lender will also consider your debt-to-income (DTI). Your DTI should be at least 50% to qualify for a USDA loan. Your DTI ratio can be calculated by multiplying all your monthly recurring debts with your gross monthly income. Rent, student, auto loan payments, credit card payments, and food expenses are acceptable monthly expenses.
- Credit Score: Lenders require credit scores of at least 640. You may still be eligible if your credit score is below 640.
In summary, you must be either a US citizen, permanent resident, or a naturalized citizen. You can use the loan to buy or renovate the property you want to purchase in a rural or suburban area if its market value is below the designated limits. It needs to be your primary residence. You can show a steady, reliable income that is sufficient to pay the loan repayments. Your income should be adequate to meet the local median income. You do not need to show the existence of another house.
CREDIT SCORE REQUIRED FOR A USDA LOAN:
Although the USDA does not have a minimum credit score requirement for mortgages, most lenders offer USDA-guaranteed loans that require at least 640 credit scores. 640 is the minimum credit score needed to be approved through the USDA’s automated loan sub-writing system. A USDA mortgage may be available to you even if your credit score falls below 640 or you do not have a credit history. It is done by the lender using manual underwriting, which assesses your creditworthiness, which usually involves reviewing your financial records and evidence of at least 12 consecutive months of timely payments. Although manual underwriting is slower than automated underwriting, it can still lead to your loan application being denied. You have the option to improve your credit score.
A USDA loan is a great way to get you started in your dream home if you have a steady income but cannot make significant improvements.
USDA PROPERTY REQUIREMENTS
- Your primary residence must not be a vacation or income property.
- The property cannot be used as a farm.
- The home appraisal must demonstrate that the property meets USDA standards.
- Water, heating, and cooling systems should be functional and up-to-date
- Structurally sound foundations and houses are essential.
- Access to the property must be from a paved or all-weather road.
PROCESS TO GET A USDA LOAN GUARANTEED:
The process of getting a USDA-guaranteed mortgage usually takes a few weeks.
- Preapproval: Before granting you mortgage preapproval, your lender will review your credit, financial, and employment history. The lender will then inform you about the maximum amount of mortgage they are comfortable giving you. Be aware that the lender might have additional requirements or conditions beyond USDA standards. Ask questions and read through all documentation. You can still search for a home in an area designated by the USDA.
- Sign off on your mortgage: Your lender will review the loan agreement before officially associating the property with you. A third-party appraiser inspects the home to ensure it conforms to USDA guidelines.
- Final USDA approval: The USDA approves your lender’s application. Sign the final documents to seal the deal, and you can move in within days.
- With a credit score of as low as 640, you can be approved.
- USDA loans do not require a down payment, unlike conventional and FHA loans.
- In most cases, the USDA monthly guarantee fee will be lower than FHA monthly insurance. You may also be able to incorporate these fees into your loan.
- Your closing costs may be included in your loan.
- You can refinance an existing USDA loan into a new USDA Loan if you have one.
USDA guaranteed, and direct loans are available to low-income, moderate-income borrowers living in rural areas. They can get mortgages that are affordable and allow them to buy modest homes without a down payment. USDA Rural Development can help you if you think you won’t afford a house or are not eligible for a mortgage.
Buyers with low or moderate incomes can take out a USDA loan. You can buy a house without any down payment and with low mortgage rates. This loan is available only to veterans who are eligible for the VA loan. A USDA-guaranteed loan is worth looking into if your home falls within a suitable area. USDA loans come with mortgage insurance. If you have the funds to make a 20% downpayment, you may prefer a conventional loan that does not require mortgage insurance.
Both USDA and FHA programs allow you to buy with a small down payment and require mortgage coverage. USDA is available with no down payment, but the home must be located in an eligible rural area, and the buyer must meet income eligibility limits. FHA requires 3.5% down but does not have any income or location restrictions. FHA has more stringent credit requirements than USDA. You require a credit score of 580 for FHA and 640 for USDA. The type of loan you need will depend on the location you are buying and your financial situation.
The USDA Rural Housing Program does not allow for the purchase or rate-and-term financing. USDA Rural Development loans are intended to assist households with modest incomes to obtain mortgage and housing loans in rural areas. The USDA encourages homeownership and helps to create stable communities for all families.
A USDA loan could be the right solution to help you pay for your dream home. Todd Uzzell, our chief financial advisor, can help you know about all your options better. To discuss the details, fill the form provided on our website and book a virtual appointment!