If you dream of living in the wide-open spaces of rural America but expect that you’ll have trouble affording a mortgage, then a U.S. Department of Agriculture loan could be just what you need to help buy or build a country home.
To get one, you and the prospective property both need to meet the USDA loan requirements.
Here’s how a USDA loan works, and a look at the pros and cons of USDA loans:
- What Is a USDA Loan?
- Types of USDA Loans
- Who Can Qualify For a USDA Loan?
- USDA Loan Fees and Costs
- Is a USDA Loan Right for You?
- How To Apply For a USDA Loan
- USDA Loan FAQ
- The Bottom Line on USDA Loans
The USDA’s mission includes promoting affordable homeownership and a better quality of life in rural areas. It guarantees fixed-rate loans with no down payment requirements for low- and moderate-income residents who want to buy, build, or upgrade a home. The government guarantee helps protect private lenders from losses, thereby encouraging them to make loans that they otherwise wouldn’t approve.
USDA home loans differ from other government-backed mortgages in that they can be used only to buy rural properties.
The USDA has designed home loan programs for different types of borrowers.
The Section 502 Guaranteed Loan Program backs loans from approved lenders that meet USDA guidelines. If the borrower defaults, the USDA covers certain losses for the lender. The guarantee reduces the risk to lenders and encourages them to offer loans with low interest rates and no down payment.
The USDA also provides loans through its Section 502 Direct Loan Program. The USDA is the lender on these single-family direct home loans, which are reserved for borrowers with low or very low income who otherwise would lack decent, safe, and sanitary housing.
Direct loan applicants also may be eligible for payment assistance. That means the USDA pays a subsidy that reduces the mortgage payment to make the loan more affordable. Although the financial assistance might not last for the duration of the loan, it can be helpful for borrowers with very low income.
Additionally, the USDA offers loans or grants for homeowners to make necessary repairs or upgrade their homes. Eligible homeowners can apply for a grant of up to $7,500, or a loan of up to $20,000. They can also apply for a combination of the two that may total as much as $27,500. Loans are repaid over 20 years with a fixed interest rate of 1%.
If you want to take advantage of these options, you’ll need to meet USDA loan requirements. Here’s a breakdown of what’s needed to determine your USDA loan eligibility.
The USDA home loan requirements include:
- You must agree to occupy the home as your primary residence.
- You must be a U.S. citizen or U.S. noncitizen national, or have qualified alien status.
- You must be able to participate in federal programs.
- You must be unable to obtain a conventional mortgage without private mortgage insurance.
You’ll also need to meet the USDA’s income limits, lender requirements, and property requirements.
The USDA requires no minimum credit score for applicants, though lenders may have their own requirements. A credit score of at least 640 qualifies a borrower for automatic approval via the USDA’s automated underwriting system. The USDA allows alternative credit options for borrowers who lack conventional credit, and lenders are encouraged to approve borrowers who have demonstrated a willingness and ability to repay debt.
Your household income may not exceed 115% of the median household income for the area in which the home you’re buying is located. The USDA has an online tool to help determine your income eligibility.
You also will need to show that your income is reliable. If you have regular employment, you must show one year of income history. If you’re a seasonal worker or self-employed, you need to provide two years’ proof of income.
Additionally, you’ll need a manageable debt-to-income ratio. That’s calculated by adding up your total monthly debt obligations and dividing it by your gross monthly income. Your DTI should not exceed 41% of your income. You can figure out your debt-to-income ratio with our free DTI calculator.
The property you’re purchasing must meet the following requirements:
- The home must be in an eligible rural area. You can determine what properties in your area qualify with the USDA’s online tool.
- You must use the home as a permanent residence. That rules out buying a vacation home or second home.
- The home must be in good condition. This includes being deemed a safe and sanitary dwelling.
- No income-producing land. The land cannot be used as a working farm, an agricultural operation, or other commercial enterprise.
- The land size must be reasonable. The size of the lot must be typical for the area.
- The home must have access to a paved road. You will need to buy a property that has direct access to a street, road, or driveway.
Depending on the area, it might be a challenge to find a home that meets USDA loan requirements. Eligible applicants may use a USDA loan to build a new home instead.
A USDA loan could offer the helping hand you need to put down roots in a rural area. But as with all mortgages, there are fees and costs associated with a USDA loan.
Saving for a down payment on a house can be a challenging goal. Traditionally, conventional loans require a 20% down payment to avoid paying for private mortgage insurance.
USDA loans are among the few options that require no down payment. However, if you’re able to put money down, it can ease your path to buying a home. Larger down payments reduce how much you need to borrow, are more likely to earn you a lower interest rate from lenders, and can help you afford a larger or more expensive home.
Buyers must pay closing costs no matter which home loan they choose. Closing costs typically include origination fees, underwriting fees, title search and insurance fees, appraisal fees, and notary fees. The maximum you can pay for closing costs on a USDA loan is 3% of the total loan amount. So, if you’re taking out a $100,000 mortgage, you could expect to pay up to $3,000 in closing costs.
With a USDA loan, you might not have to pay thousands in closing costs upfront. The program allows you to borrow up to 100% of the home’s appraised value. If the purchase price is less than the appraised value, you may be able to roll your closing costs — including the upfront guarantee fee — into the mortgage and repay them over time.
Instead of private mortgage insurance, USDA loans require guarantee fees. There’s an upfront guarantee fee paid at closing, and an annual guarantee fee paid monthly. For the fiscal year beginning Oct. 1, 2021, the upfront guarantee fee is 1% of the loan amount, and the annual fee is 0.35%. The USDA charges the guarantee fees to the lender, which can pass the costs on to the borrower.
Now that you know more about USDA loan requirements, it’s time to decide whether one is right for you. Here are some pros and cons of USDA loans.
These are some of the benefits of taking out a USDA loan:
- No down payment required. With rising home prices, it’s more difficult for buyers to save up for the traditional 20% down payment.
- More lenient credit requirements. USDA loans are geared toward borrowers whose income and credit history make it difficult for them to afford a conventional mortgage.
- Specialized for rural homes. The program is designed to meet the needs of rural communities.
As with all financial decisions, there are some drawbacks to choosing a USDA loan:
- Location limits. USDA loans are only available for homes in eligible rural areas. “To qualify for the USDA loan, the home you should get must be located in a rural area that has a population of only 35,000 or less,” says Paul Sundin, a certified public accountant and tax strategist based in Chandler, Arizona.
- No home-based businesses. The inability to use the property to generate income could be a disadvantage for some homebuyers.
- Low-income borrowers only. Since your household income must be less than or equal to 115% of the median household income, many potential borrowers won’t qualify for a USDA loan.
Have you decided that a USDA loan is right for you? Here’s how to apply.
You’re required to work with a USDA-approved lender, so as you’re shopping around, make sure to verify that potential lenders can provide USDA loans.
To apply for a single-family direct home loan, contact the nearest USDA service center.
Getting preapproval involves submitting preliminary documentation to a lender. You’ll need to provide income statements, bank statements, proof of assets, credit reports, and tax returns. Although a preapproval is not a guarantee that the lender will officially approve your loan, it gives you an idea of what you should be able to afford, which is helpful when you’re shopping for homes and preparing to make an offer.
Once your offer is accepted by a seller, you move on to closing. Your lender will appraise the property and finalize the terms of your mortgage, and the home will be inspected. You’ll pay the closing costs, and after the loan is funded and the paperwork is signed, you’ll own the home.
Here are the answers to common questions about USDA loans.
USDA loans don’t require mortgage insurance. However, you’ll have to pay guarantee fees. For the fiscal year beginning Oct. 1, 2021, the upfront guarantee fee is 1% of the loan amount, and the annual fee is 0.35%.
You’re not alone if you are wondering, how long does it take to get a mortgage? Most home sales take 30 to 60 days to close. Lenders have 90 days to close the loan from when the USDA issues its conditional commitment; that extra time may be needed if you run into delays. There’s also an opportunity for a one-time, 90-day extension.
USDA loans offer a way for qualified borrowers with lower income or nontraditional credit to afford buying a safe and sanitary home in rural areas. For those aspiring buyers, understanding how USDA loans work — and how to qualify — is the first step on the path to owning a home in the country.