What is a USDA loan and are you eligible?
Personal Finance Insider writes about products, strategies, and tips to help you make informed decisions with your money. We may receive a small commission from our partners, such as American Express, but our reports and recommendations are always independent and objective.
What is a USDA loan?
A USDA loan is a mortgage guaranteed by the United States Department of Agriculture. It is aimed at low to moderate income borrowers who buy a house in a rural or suburban area.
There are two main types of USDA home loans:
- Guaranteed: This guy is backed by the USDA and you apply through a participating lender.
- Direct: USDA actually issues the loan, so you apply directly to USDA.
USDA Direct loans are intended for low-income borrowers and you must meet more stringent criteria. When people refer to a USDA loan, most are referring to a secured loan, aka the USDA’s Secured Housing Loans for Rural Development program – and this is the type of USDA loan that we explore in this article. article.
How a USDA Loan is Different from Other Types of Mortgages
There are two main types of mortgage loans: conventional loans and government guaranteed loans.
A conventional loan is not guaranteed by the government. A private lender, such as a bank or credit union, gives you the loan without government insurance. But you can choose a conventional mortgage backed by government sponsored mortgage companies Fannie Mae or Freddie Mac. A conventional mortgage requires at least one 620 credit score, a Debt-to-income ratio of 36%, and 3 to 10% for a advance payment.
A government guaranteed loan is secured by a federal agency. If you don’t pay a government guaranteed mortgage, the agency pays the lender on your behalf. When a lender gives you a government guaranteed mortgage, it’s like the lender is getting insurance on your loan. It is easier to qualify for a government guaranteed mortgage than a conventional mortgage.
A USDA Rural Development Guaranteed Home Loan is a type of government-backed loan, which means that the eligibility conditions are more flexible.
The three types of government guaranteed mortgages are FHA, VA, and USDA loans. Here’s how they’re different:
- FHA loan: A Federal Housing Administration mortgage is not intended for a specific group of people. You can qualify with a down payment of 3.5%, 43% DTI and 580 credit score.
- VA loan: A Veterans Affairs mortgage is intended for serving or retired military personnel. Many lenders require a credit score of 660 and a DTI of 41%, but you don’t need the money for a down payment.
- USDA loan: This type of loan is specifically intended for low to moderate income borrowers who purchase homes in rural or suburban areas of the United States. You’ll likely need at least a 640 credit score and a 41% DTI, but you don’t need a down payment.
Who is eligible for a USDA loan?
A lender looks at two factors to determine if you qualify for a USDA loan: your property and your financial profile.
You are eligible for a USDA loan if you buy a house in a rural or suburban area. The population restrictions are 20,000 for some counties and 35,000 for others.
If you already know the address of the house you want to buy, enter the information in the USDA Property Eligibility Site. You will need to select the type of USDA loan you are interested in, so you will choose “Secured Single Family Home” if you want a secured USDA loan.
Eligibility of borrower
Here’s what you need to qualify for a USDA loan:
- You must be a US citizen or permanent resident.
- Your household should have a low to moderate income level. The maximum income required depends on where you live, and you can see your county income limit here.
- You will need to provide proof of stable income for at least the past two years.
- You should have a good credit history. Most lenders require a credit score of 640 or higher, although there are exceptions.
- Your monthly mortgage payments should not exceed 29% of your monthly income. This number includes your loan principal, interest, insurance, taxes and contributions to the owners’ association.
- Other debt payments should be 41% or less of your monthly income. However, you may qualify with a higher debt ratio if your the credit score is very good or excellent.
There is no maximum borrowing limit. A lender will allow you to borrow a certain amount based on your financial profile.
The pros and cons of a USDA loan
A USDA loan might be right for you, as long as you are aware of the potential tradeoffs. Here are the pros and cons of getting this type of mortgage:
- Low interest rate. You will likely pay a lower rate on a USDA loan than on a conventional, FHA, or VA mortgage. Keep in mind that you will get an even better rate with a great credit score, a low debt-to-income ratio, or money for a down payment.
- No down payment. Other than a VA loan (which is reserved for borrowers associated with the military), a USDA loan is the only type of mortgage that does not require money upfront, making it easier to get a mortgage if you don’t have a lot of money saved.
- Low insurance costs. You have to pay for mortgage insurance with a USDA loan, but it’s less than what you would pay with other types of mortgages. You will pay 1% of your principal at closing, then an annual premium of 0.35% of your remaining principal. If you got an FHA loan, you would pay a mortgage insurance premium of 1.75% on closing, and your annual premium would rise to 0.45% to 1.05% of your mortgage. you would pay private mortgage insurance on a conventional loan until you reach 20-22% of your home equity, which could be time consuming and expensive if you don’t have a big down payment.
- You can refinance into another USDA loan. If you later decide that you want to refinance to obtain lower monthly payments or a better interest rate, you can refinance into another USDA loan.
- Location restrictions. USDA loans are intended for residents of rural and suburban areas of the United States. If you want to buy a house in the city or in an area with more than 35,000 people, you probably won’t qualify.
- Income restrictions. You must have low to moderate income (the exact number varies by county) to be eligible for a USDA loan.
- No adjustable rate loans. You can only get a fixed rate with a USDA loan, not an adjustable rate. While this is limiting, the good news is that fixed rate mortgages are the best deal right now. The rates are at historically low levels, so you can get a really low rate for the life of your loan.
- Only single family homes. You cannot use a USDA loan to purchase a multi-family home. If you are not looking for a single family home, you might want to consider an FHA loan instead.
- No cash refinancing. A refinancing of collection is a type of loan that allows you to receive money if you have built up equity in your home. You can refinance a USDA loan, but cash refinances are not an option.