A USDA home loan is a loan that is guaranteed by the Federal government through the USDA. The USDA home loan is a program of the USDA Office of Rural Development, an agency within the USDA. The RDA was established in 1990 in an amendment to the Consolidated Farm and Rural Development Act of 1972. The goal of the RDA and the home loan program is to improve the economy and quality of neighborhoods in rural America by providing an incentive for homebuyers to purchase property in qualified rural areas.
The USDA home loan program allows low and moderate income homebuyers to purchase homes to serve as their primary residences in eligible rural areas without requiring a down payment. Under this program which is also sometimes called Rural Housing Loan program or Section 502 Loan program, qualified borrowers can purchase, build, rehabilitate and relocate a property into an eligible rural area while financing 100% of the purchase price.
Lenders are willing to offer 100% financing to borrowers under the USDA home loan program because the loans are backed 90 percent through the federal government. This eliminates most of the risk to the lender, allowing more borrowers to qualify for these loans without a high down payment requirement. This is the only no down payment loan option currently available to those who are not in the military and therefore do not qualify for the VA home loan program.
In order to qualify for the USDA home loan program, both the borrower and the property must meet certain criteria. The borrower must fall within the middle-to-low income bracket for their family size in their state. Moderate income is defined as the greater of 115 percent of the U.S. median family income or 115 percent of the average statewide and state non-metro income for the family size. This means the income limits will vary depending on the state in which the borrower lives. Borrowers also must agree to occupy the home as their primary residence, be able and willing to make payments in a timely manner and be legally able to buy a residence in the United States. The USDA home loan program does not have a minimum credit score, but lenders may set this eligibility as they see fit. Most lenders who offer the home loan require a score of 620 or higher, although some do offer financing with 580 FICO. Borrowers who have filed bankruptcy in the past will need at least three years between the bankruptcy discharge date and the application for a USDA loan. In certain situations, extenuating circumstances that led to the bankruptcy may make it possible for the applicant to apply for a USDA loan after less than two years from bankruptcy discharge.
For the property to be eligible, it must be located in a “rural” area, but this does not mean that it has to be in a farming community or miles from stores and restaurants. Most small towns actually meet the definition of rural, as do most suburbs. In fact, only about 3 percent of the United States is considered ineligible. Additionally, the property must also be owner occupied and be considered safe and adequate housing.
USDA home loans are 30 year fixed-rate home loans and borrowers are unable to attain an adjustable rate or shorter term loans under this program. The guidelines require homeowners to pay a mortgages insurance premium to help fund the program which is 2% of the loan size at closing and 0.4% of the remaining principal balance amortized annually and paid through the monthly payment. The upfront mortgages insurance is added to the balance of the loan, and thus it is not a cost due at closing. The USDA monthly mortgage insurance is also lower than FHA and conventional mortgage financing.
Maximum Loan Amount
The USDA does not set a maximum loan amount, but the lender will have a maximum for each individual borrower. This will be based on credit score, debt to income ratio, assets, income and any previous repayment problems for mortgages or rental property. Typically, the debt to income ratio for a borrower with a credit score below 660 cannot be more than 41%, but this may be negotiable based on the lender’s requirements.
USDA Guaranteed Loans
The type of loan most borrowers use when getting a USDA loan is a USDA Guaranteed Loan. This provides 100 percent financing for home purchases provided the home is in a qualified rural area. In addition, the USDA repair escrow option allows borrowers to borrow 100 percent of the cost of a home, and then set up a repair escrow to cover the cost of repairs necessary to make the home livable. Borrowers may finance the lesser of 10 percent of the home’s appraised value or $10,000 for repairs through this repair escrow.
USDA Direct Loans
Borrowers who are in very low or low-income households may qualify for a variation of the USDA home loan program called the USDA Direct Loan. These borrowers must have incomes between 50 and 80 percent of the average income in their area to qualify. This home loan program provides payment assistance in the form of a subsidy that will reduce the monthly mortgage payment for a short time. In order to qualify, the borrower must be without decent, safe or sanitary housing and be unable to get a loan from another source with a repayment amount that is reasonable for the borrower’s income.
While not a separate loan type, the USDA home loan program can be used as a refinance option on qualified properties if the rate or term of the USDA loan is more favorable to the borrower than the existing loan although a cash out refinance is not permitted.
Frequently Asked Questions
Can a borrower use USDA loans to purchase a second home?
In order to use the USDA home loan program, the borrower must live in the home as his or her primary residence. This means it cannot be used to purchase a vacation home or rental property. Borrowers can however keep their existing homes as a vacation home or rental property and use the USDA loan to buy the new home which will become their primary place of residence.
Can I use the USDA home loan for a rental property?
No, USDA home loans must be used for a primary residential home only. Multi-family properties may be eligible, but only if the buyer buys just one unit and intends to live in that unit.
Can I use the USDA home loan program to purchase a working farm?
No, the USDA home loan program is designed for residential property in qualified rural areas and it does not include agricultural property.
Can USDA home loan funds be used to purchase manufactured homes?
Yes, the USDA home loan program can be used to purchase a new manufactured house. The home must be constructed following the Federal Manufactured Home Construction and Safety Standards and meet all HUD Zone III energy ratings. The home must be purchased from an approved Rural Development Dealer and be mounted to a permanent foundation with the wheels, hitch and axles removed. All homes whether manufactured or not, must be built on permanent foundations and be properly anchored to resist wind damage with on site utilities.
Are USDA mortgage rates competitive?
USDA mortgage rates are competitive with conventional 30-year fixed rates and may be lower than comparable conventional loans. Because the mortgage insurance rates are lower, this is typically the most affordable loan option for borrowers who don’t have a significant down payment for their home purchase.
How do I apply for a USDA loan?
USDA loans come from lenders, so the application process starts with finding a lender who offers this loan program. The lender will approve or deny the loan and provide the money if you are approved.
Can a borrower with poor credit get a USDA home loan?
This decision is ultimately in the hands of the lender. Lenders are often willing to accept borrowers with lower credit scores because of the loan’s guarantee, but this is not guaranteed as every lender will have its own minimum required credit score.
My income is above the income limits, is there any way for me to qualify?
Borrowers may be able to get USDA loans even with an income level above the 115 percent cutoff. The USDA has several deductions that may be able to reduce a borrower’s qualifying gross household income to help them qualify. These include having a disabled or handicapped individual in the home, documented childcare expenses, documented medical expenses for family members age 62 or older and full time students over the age of 18. Borrowers who wish to use the program should discuss their income qualifications with a lender before to determine their true qualification.
Can someone cosign for a USDA loan?
If a borrower lacks sufficient income to qualify for a USDA home loan, the underwriting guidelines do allow qualified cosigners who do not live in the property to cosign the loan for the buyer. However, cosigners cannot make up for a borrower’s poor credit history.