What is a USDA Home Loan and How do I Qualify?

USDA Loans are another government backed mortgage that not many people know about. It is mainly issued to homeowners in rural or suburban areas and is also called by other names such as The USDA Rural Development Loan or Rural Housing Loan.

What are USDA Loans?

A USDA Home Loan is a government loan that functions similarly to a FHA Loan (The Federal Housing Administration). The US Department of Agriculture (USDA) created the USDA Rural Development Guaranteed Housing Loan Program in 1991 in an effort to boost rural home ownership. Most loans that are guaranteed by the government, such as FHA Loans and VA Loans, do not require the borrower to put down the usual 20% down payment. While FHA Loans require a minimum of 3.5% as a down payment, a USDA Loan does not require a down payment.

A USDA Home Loan is a 100% financing home loan with no down payment required. While this type of mortgage is guaranteed by the USDA, the USDA cannot issue out the loan. They are simply guaranteeing it, which means that they promise that the mortgage will not default by taking responsibility for 10%. This decreases the risk associated with issuing a loan without collecting any down payment. A USDA Home Loan can only be obtained by an approved lender.

What are the benefits of a USDA Loan?

Besides not requiring a down payment of any kind, the USDA loan program offers other mortgage benefits for its homebuyers. The borrower can choose either a 15 or 30 year term with a fixed interest rate that is comparable to the market. One would automatically think that because a USDA Loan does not require a down payment and also accepts lower credit scores, the interest rate would be incredibly high, but that is not the case. Due to strong government backing, the interest rates that come with this type of loan are competitive.

Since a USDA Loan does not require the borrower to have perfect credit, more aspiring homeowners are able to qualify for this type of loan. You can have less than perfect credit history and those with a credit of at least 640 can get streamlined processing, meaning that there is less paperwork and time taken out of the mortgage process, which makes it easier for both the lender and the borrower. There is technically no minimum credit score required for this type of mortgage loan, but there are the perks of time-saved and less effort involved if you qualify for it.

How to qualify for a USDA Loan?

USDA Guaranteed Home Loan Eligibility Requirements: The Location

Since this type of loan is specifically designed for those who have lower income and live in a less concentrated area, the location of the home must be in a USDA-eligible area in order to get a USDA Loan. If you are curious to see where the home lies, there are maps on the USDA website where you are able to zoom in and widen the range to see where a property can be located while still being eligible. It is mandatory that the home is in a rural area in order to even be eligible, but the term “rural” can mean multiple things.

Based on USDA standards, “rural” areas are typically defined as less inhabited towns and cities that have a population up to 20,000. If you have chosen a location that exceeds the population limit for a USDA Guaranteed backed home loan, you can still get one by proving that there is no access to mortgage credit. The USDA created this loan to promote and stimulate the community with real estate. If you find yourself in a position where your lender is hesitant to issue you a loan (any type of loan) because the area is undeserved, you can work with your lender to petition in getting a USDA Guaranteed Home Loan. This type of exception is fine because it is fulfilling the original purpose of this loan.

USDA Guaranteed Home Loan Eligibility Requirements: Property Types

While USDA Home Loans fall under The Department of Agriculture, these home loans do not have to apply to only farmhouses. USDA Loans are actually not aimed to finance farmhouses and properties with large plots of land, but rather a standard single family home even including condominiums and townhouses.

The home you are purchasing must also be your primary residence. This means that you cannot use a USDA Home Loan to purchase a second home, investment property, or a rental property. During closing, the property will have to be evaluated by an appraiser (this evaluation is called an appraisal). An appraisal is a mandatory part of getting a home loan because it ensures the lender that this investment is worth the money they will be giving to you in order to purchase it. An appraisal also verifies that the home has met the USDA’s minimum property requirements.

USDA Guaranteed Home Loan Eligibility Requirements: Income

With every mortgage, there are requirements that the borrower must meet in order to get one. There are different requirements for each type of loan such as a down payment of a certain amount, a minimum credit score, citizenship, etc. Because USDA Guaranteed Home Loans don’t require a credit score or a down payment, there are more eligibility requirements that the buyer must meet.

Since this type of loan had families with low earning incomes in mind, there is a household income requirement. While most loan types want to make sure that you are earning enough money to comfortably make your mortgage requirements, a USDA guaranteed home loan requires that the buyer earn up to 115% of the region’s median income. While you are able to earn more than a moderate-income, there are income limits where you can’t be earning too much because this program is intended for those who can’t afford a conventional mortgage and areas with expensive price tags. Similar to a FHA Loan, the buyer will have to provide proof that they have been employed by the same employer for at least 2 years.

How to Calculate Your Debt-to-Income Ratio for a USDA Home Loan

The Debt to Income (DTI) Ratio is the comparison of your income to your monthly financial obligations, but it can also help you to calculate how much you can actually afford in terms of paying for a home. The DTI ratio for a USDA loan is set at 29/41. The first number is called the front-end ratio and the second number is the back-end ratio.

The first thing you want to do is add up all of your income, before taxes and deductions. In order to calculate your front-end ratio, get your monthly income gross figure and multiple that number by 29% or .29. The number that you get is the mortgage payment that you can afford. This payment usually reflects the mortgage payment with interest, the home insurance, HOA fees, and taxes.

The back-end ratio is calculated the same way, using your monthly gross income and multiplying that by 41% or .41. The resulting number is the maximum amount allowed that can go toward ALL of your debt. This includes not only your mortgage, but student loan payments, car payments, credit card payments, etc.

What is a Recapture Period?

Because this type of loan is meant for those who are earning low income salaries, there are regulations put into place to ensure that people don’t take advantage of it. This type of loan is meant for a primary residence so no investment properties are allowed. There is a re-capture period where if the borrower only lives in the home for a handful of years and then sells it and makes a profit, the USDA will be able to claim a portion of the profit. If the borrower resides in the home for about 10 years and has a job change that requires them to pick up and move, they are exempt because they’ve lived in the home long enough to prove that it was actually used as their primary residence.

Do USDA Loans Have Closing Costs?

Although this type of loan is a zero-down mortgage with 100% financing, closing costs must still be paid. Closing costs are typically 2%-5% of the loan amount and takes care of the loan origination fees, the appraisal, the home inspection, etc. Even if the seller were to reduce the selling price of the home in order to accommodate the closing costs, the borrower would still be required to have money to pay for those. The only exception to putting forth money to pay for closing costs would be if the seller opted to actually pay for your closing costs, not by decreasing the selling price to accommodate the closing costs.

Do USDA loans have PMI?

First off, for those that don’t know, PMI stands for private mortgage insurance. This type of insurance is designed to help protect a lender if you default on your loan. Unlike conventional loans, USDA loans don’t have PMI, but do require mortgage insurance premiums such as upfront guarantee fee and an annual fee. USDA mortgage insurance fees include an upfront guarantee fee equal to 1% of the loan amount and an annual fee that is equal to 0.35% of the loan amount. The upfront guarantee fee is a one-time fee that is paid at closing and financed into the loan, whereas the annual fee is paid over the life of your loan and included in your monthly loan payment.

Can you refinance a USDA loan?

The short answer is yes and depends on if your mortgage lender offers it. The USDA offers three refinancing options for homeowners: USDA streamline refinance, USDA streamline-assist and non-streamlined refinance. There are, however, a few requirements that you’ll need to meet before you can begin the refinance process.

USDA Streamline Refinance Eligibility

This refinance is for homeowners current on their USDA loan for 12 months that are able to refinance without a new appraisal.

Your mortgage must be a USDA Loan, either Guaranteed or Direct
The mortgage must be current for 180 days prior to the refinance application
The loan must have closed 12 months prior to the refinance request
You must meet the USDA’s debt-to-income ratio and credit requirements
The maximum loan amount can’t exceed the original loan amount

USDA Streamline-Assist Refinance Eligibility

This refinance does not require a new appraisal, credit checks or updated calculations of debt-to-income ratios. Borrowers with little to no equity can apply.

The refinance needs to result in a $50 or greater reduction in the borrower’s current monthly payment
The loan must be current for 12 months prior
USDA direct loans will require a new appraisal
Borrowers can be added, but not removed to the note

Non-Streamline Refinance

This refinance is similar to the USDA streamline, but borrowers are required to get a new appraisal.

The bottom line

A USDA Guaranteed Home Loan is a great type of loan for people who don’t qualify for conventional loans, don’t quite have enough saved up, and have no plans on living in an urban environment. There are a lot of restrictions, such as income eligibility, being a US citizen, etc., but there are so many benefits associated with this loan. If you qualify for this, I would definitely look into it and explore the option.