USDA loans are a mortgage loan for low to moderate income families living in a rural area. They offer flexible financing options to make it easy for families to afford a primary residence. The program was created to ensure that most Americans have a home for their families.
To qualify for the loan, you must prove eligibility for the loan by proving you make less than or equal to 115% of the area’s average income and that you’ll live in a rural area as deemed by the USDA.
If you’re eligible, you may qualify for a mortgage that doesn’t require a down payment and has low closing costs to make it easy to afford a home.
What are USDA Loans?
USDA loans are backed by the United States Department of Agriculture. They started the program to help low-income families afford a home. You don’t deal directly with the USDA when you apply for a USDA loan, but they do have the final say in your loan approval.
If you’re eligible, you can use a USDA loan to buy a moderate home to live in. You can’t use it to buy investment homes or fix and flip homes, but only a home to live in. The program is backed by the government, giving lenders a guarantee should borrowers default which is how lenders can have such flexible guidelines for the program.
Who Offers USDA Loans?
You can get USDA loans from a USDA-approved lender. Unlike other government-backed programs, USDA lenders may be slightly hard to find. This is because the loan is a niche product that caters to low-income families in rural areas and not all lenders specialize in that niche.
Your best bet for a USDA loan is to work with a mortgage broker. They work with hundreds of lenders and will likely have a good match for you if you need a USDA loan. We recommend that you get offers from several lenders so that you can see what options you have and choose the loan that makes the most financial sense.
Since USDA loans are such a niche product, you might find that different lenders have different requirements so it’s always important to shop around.
Who is Eligible for a USDA Loan?
Eligibility for a USDA loan is different from qualifying for it. First, you must prove you’re eligible for the program.
To be eligible your entire household’s income must be less than the USDA states. You can see if your family’s income qualifies here. Remember, your household income includes all income from you, any co-borrowers, any adult children living in the home, or any other relatives or adults living in the home. The USDA considers all working adults capable of contributing to the home’s expenses and includes it in the calculation to determine eligibility.
If your income makes you eligible, you must also promise to buy a home in a rural area. The home must be modest for the area and not have any luxurious components or be an excessive size for the area.
How to Qualify for an USDA Loan
Qualifying for a USDA loan is different from being eligible. If the USDA determines you are eligible, you must qualify with a lender.
The USDA sets specific guidelines lenders must require, but lenders can add to those requirements too. In general, here’s what you can expect:
- Minimum 640 credit score
- Maximum 41% debt-to-income ratio
- Stable income and employment for the last 2 years
- Have enough assets to cover your closing costs
- No recent bankruptcies or foreclosures
- Proof you don’t qualify for any other type of financing
These are the minimum qualification factors. Some lenders require stricter guidelines, especially if they lend in an area with a high risk of default. If one lender turns you down, don’t be afraid to try another as there are many that offer the program.
Down Payment Funds for an USDA Loan
USDA loans don’t require a down payment. You can buy a home with no money down. If you want to make a down payment you can, but it’s not required.
You will need money to cover your closing costs, which is usually around 3% of the purchase price with USDA loans, but it varies by lender. Your lender will need to verify that you have the funds to cover the closing costs by evaluating your last two months of bank statements to make sure the funds you’re using are yours and not borrowed.
You may be able to get seller concessions to get help with the closing costs. Some lenders also cover the closing costs for you. Ask your lender what options you have if you can’t afford to pay them upfront.
Keep in mind, if you don’t make a down payment, you are borrowing 100% of the home’s purchase price which means you’d have no equity in the home when you first buy it. As you pay the mortgage down, you’ll build equity, but it could take many years to do so.
What about Mortgage Insurance?
Since USDA loans are a government loan, there is mortgage insurance both upfront and annually.
The USDA charges a much lower amount than most other programs, though, which means you save even more money.
Upfront, USDA borrowers pay 1% of the loan amount. This means you pay $1,000 for every $100,000 you borrow. Since USDA loans are for moderate homes, the loans typically don’t go very high, so the upfront costs stay low.
You pay the upfront mortgage insurance at the closing. If you can’t afford it, you can wrap it into your loan amount or ask the seller to pay it.
The USDA also charges mortgage insurance for the life of the loan at 0.35% of the outstanding loan amount annually. This means you’ll pay $350 a year for every $100,000 you borrow, which comes out to $29 a month.
The annual mortgage insurance you pay decreases each year as your mortgage balance decreases, but you’ll pay mortgage insurance until you pay the loan off in full.
Pros and Cons USDA Loans
USDA loans have pros and cons – it’s important to understand both sides so you can decide if it’s right for you.
No down payment required
USDA loans make it easy for low-income families to afford a home. If you don’t have a primary residence and don’t qualify for any other financing, you can get USDA financing with no down payment. This means you can own a home without investing any money up front.
Flexible underwriting requirements
Not only do USDA loans not require a down payment, but you also don’t need perfect credit either. The program has flexible qualifying guidelines to help families that don’t qualify for other loan types such as FHA or conventional loans to be able to buy a home.
USDA loans have competitive rates and fees
USDA loans are competitive, offering low rates and fees to borrowers to make it easy to afford a loan. Since the program is for low-income families, it is a great way to ensure that families can afford the loan they need to buy a home.
You can make too much money and not qualify
If you make too much money, you might not qualify for the program. If you have a low credit score, though, you might not qualify for any other loan options either. Since the program includes income from all adults, you might find it hard to be eligible.
It’s not available on all homes
Since the USDA program is only for moderate homes to ensure that all families have a home to live in, it doesn’t work on homes considered excessive for the area. You might be limited to a smaller house or a house with less features to make sure that it fits within the program guidelines.
There are specific appraisal requirements
Because the loan is government-backed, there are specific appraisal requirements that other loan programs don’t have. This can make it harder to pass the appraisal process. Some sellers won’t deal with USDA financing because of the more difficult appraisal guidelines.
USDA financing can be a great way to buy a home when no other financing is available to you. The program is only for low to moderate income families that live in a rural area, so it’s a niche product, but it’s helpful for those who need it.