If you bought a home using a U.S. Department of Agriculture loan, refinancing your mortgage may be easier than you think.
While homeowners are unable to get a cash-out refinance from the USDA, the agency’s simplified programs can make it relatively easy to refinance to a new loan that could save them money on their mortgage.
But a USDA refinance requires homeowners and their properties to meet USDA mortgage refinance guidelines, so read on to learn how it works and how to get one:
- What Is a USDA Loan?
- Why Refinance a USDA Loan?
- Types of USDA Refinance Loans
- USDA Refinance Fees
- Pros and Cons of a USDA Mortgage Refinance
- How To Refinance a USDA Mortgage
- The Bottom Line on USDA Mortgage Refinancing
What Is a USDA Loan?
The USDA’s Rural Development program offers home loans as part of its mission to improve the economy and quality of life in rural areas of the United States. For homebuyers who may be otherwise unable to afford a mortgage, USDA loans allow them to buy, build, or repair a safe and sanitary home in qualified rural areas.
Most USDA loans are issued by private lenders. The USDA guarantees qualified loans to protect those lenders against losses, and to encourage them to extend loans to homebuyers who otherwise wouldn’t be able to get a mortgage.
The USDA also offers direct loans to applicants who have very low income.
What are the USDA loan requirements?
As with all government-backed loans, there are specific USDA loan requirements for the borrower and the property they want to buy, including:
- USDA loans can be used only to buy homes in rural areas of the country. The USDA generally defines a rural area as having a total population of fewer than 35,000 residents. You can look up a property’s USDA eligibility with the agency’s online search tool.
- The home must be safe, sanitary, and accessible via a paved road.
- Homes must be located on land that’s typical in size for the area.
- The property cannot be used to generate income.
- Borrowers must agree to occupy the home as their primary residence.
- They must be a U.S. citizen, U.S. noncitizen national, or qualified alien who is eligible to participate in federal programs, and be unable to obtain a conventional mortgage without private mortgage insurance.
Why Refinance a USDA Loan?
A USDA refinance can help homeowners save money in both the short and long term.
Mortgage refinancing replaces your existing loan with a new one that usually has more-favorable terms, such as a lower interest rate. A lower interest rate reduces the monthly mortgage payment and also can decrease the total amount of interest you pay over the life of the loan.
The USDA offers programs that reduce the amount of documentation that borrowers must provide, which can make the refinance process significantly less intimidating.
“The documentation process is quite simplified,” says Matt Ward, a real estate agent at The Matt Ward Group in Franklin, Tennessee. “Consequently, it ensures a convenient closing.”
However, one popular reason to refinance is unavailable with a USDA refinance: cash-out refinancing. A cash-out refinance allows homeowners to take out a new mortgage based on their home’s current value. If that value has increased or the principal on the home has been paid down over a number of years, homeowners can borrow thousands of dollars at potentially low rates to use for major expenses.
Even with that option closed, a USDA refinance can help homeowners restructure their finances and make their home more affordable.
Types of USDA Refinance Loans
There are three types of USDA refinances. Each type has a 30-year term, and homeowners must have paid their existing USDA loan on time for at least 12 months before refinancing.
The USDA streamline refinance offers a simplified refinancing experience to qualifying homeowners with existing USDA loans.
Unless you have a USDA direct loan and receive a subsidy, a streamline refinance lets you skip the appraisal process. You also can remove borrowers from the mortgage with a USDA streamline refinance.
You might be able to add the required USDA guarantee fee to your new mortgage balance and avoid having to pay the fee upfront. However, the new loan amount cannot exceed the original loan amount, and closing costs cannot be included.
Eligibility for a streamlined loan
To be eligible for a streamlined loan, you cannot have any late mortgage payments in the previous six months. You’ll also need to meet the USDA-approved private lender’s credit requirements, such as a maximum debt-to-income ratio or minimum credit score.
Like a streamlined loan, an appraisal is not required to close on a streamlined-assist refinance, unless you have a USDA direct loan and receive a subsidy.
Streamlined-assist borrowers can roll their closing costs into the loan, as long as the new loan amount doesn’t exceed the original loan. You can add a borrower to the mortgage in the process, but cannot remove a borrower unless they have died.
One important requirement for the streamlined-assist refinance is that you need to prove a net tangible benefit. That means the refinance must reduce your monthly mortgage payment, including interest and taxes, by at least $50.
Eligibility for a streamlined-assist loan
The first checkpoint for eligibility is making on-time loan payments for the past 12 consecutive months. A streamlined-assist refinance doesn’t set a maximum debt-to-income ratio or require a new credit check.
A nonstreamlined refinance is essentially a repeat of the entire mortgage process. In addition to needing an appraisal, you’ll go through the same steps as when you took out your original USDA loan, and likely need to provide detailed documents such as tax returns, proof of income, and bank statements. During this process, you can add or remove borrowers.
Note that the new loan value cannot exceed the new appraisal value — even if you choose to include your closing costs.
Eligibility for a nonstreamlined loan
Borrowers seeking a nonstreamlined refinance will need to have a proven record of on-time payments for the last six months.
Lenders will also evaluate a borrower’s debt-to-income ratio and credit score. Although the USDA doesn’t require a minimum credit score, it does suggest that borrowers have a score of at least 640.
USDA Refinance Fees
USDA refinances come with fees you’ll need to pay in addition to closing costs in order to finalize the loan. As with your existing USDA loan, there’s an upfront guarantee fee of 1%, and an annual guarantee fee of 0.35% per year.
For example, let’s say that you’re taking out a USDA home loan of $150,000 with a 2.5% interest rate. The upfront fee would be $1,500, which is rolled into your loan amount to become $151,500. You would pay $43.73 per month to cover the annual fee in your first year of repaying the loan. The annual fee is recalculated each year, so you would pay less per month in each subsequent year — all the way down to $1.12 per month in the final year of the loan.
Pros and Cons of a USDA Mortgage Refinance
If you meet the USDA loan requirements, refinancing can save you money. But you’ll want to weigh the pros and cons before diving in.
Pros of a USDA refinance
Let’s start with the advantages of a USDA refinance:
- Skipping the appraisal. You might not need to get an appraisal with a streamlined or streamlined-assist refinance, speeding up the process and removing a potential obstacle to the approval of your new loan.
- Competitive mortgage rates. USDA loans usually have competitive interest rates that could save you money over the course of the loan.
- Rolling closing costs into the new loan. Although you must pay closing costs no matter what, you might not need to bring that money to the closing table.
Cons of a USDA refinance
Now for the disadvantages of a USDA refinance:
- No cash-out option. If you want to tap into your home’s equity, you’ll need a different type of mortgage.
- Thirty-year terms only. You have one option for your repayment period, and that’s to take a 30-year term. This means you’ll be extending your loan term, which may cost you more in the long run depending on how far along you are in repaying your current mortgage.
- Income limits still apply. The income limits for a USDA loan in your county still apply. If your income has increased since you bought your home, you may be making too much to be eligible for a USDA refinance.
How To Refinance a USDA Mortgage
If you’ve decided that a USDA mortgage is right for you, then here are the steps you should take.
Determine your financial needs
Before you dive into a refinance, it’s critical to assess your financial needs. The limits on USDA refinancing make it ideal for homeowners who want to lower their interest rate and monthly payment to make their home more affordable. If you’re looking to pay off your mortgage more quickly or to tap into the equity in your home, you’ll need a different type of loan.
Gather your records
The type of USDA refinance you choose will determine what kind of documents you must collect. You’ll need to pull together information about your credit score, your income, and the details of your current mortgage for most refinances. You may be able to get by with less paperwork based on the type of USDA refinance you choose.
It’s a good idea to organize these documents before you start shopping for a loan, so you’re ready to provide them to lenders.
Shop for a loan
Choosing a lender is an important step after selecting which type of USDA refinance is best for you. Terms vary from lender to lender, and you’ll be repaying your USDA loan for 30 years, so finding the best terms is important to your bottom line.
It’s a good idea to get a loan estimate from at least three lenders before deciding on one.
Submit your documents
Once you choose a lender, it’s time to provide your documents. From there, you’ll work with your lender to finalize and close on your new USDA loan.
The Bottom Line on USDA Mortgage Refinancing
Refinancing your USDA refinance can be a big help in restructuring your finances and making your home more affordable. While you can’t use it to borrow equity and are locked into a 30-year loan term, the process can offer a simplified way to lower your interest rate and reduce your monthly mortgage payment to save money.