Homebuyers looking to escape the hustle and bustle of city life may long for a quieter life in the country. But anytime you’re considering making a major lifestyle change, finances can become an issue.
If this sounds like you, you may be able to qualify for a USDA loan. This government-sponsored loan program focuses on houses located in designated rural and suburban areas.
What is a USDA Home Loan?
A USDA home loan is a type of mortgage for eligible rural and suburban homebuyers. It’s offered by the United States Department of Agriculture. USDA loans are issued through the USDA Rural Development Guaranteed Housing Loan Program.
One of the biggest draws of the Rural Development program is that it doesn’t require any down payment. So you can purchase your own home with a minimal amount of cash.
If you think this sounds like a good opportunity, you may be right. Keep reading to find out the benefits of applying for a USDA loan.
4 Benefits of a USDA Loan
Listed below are the four biggest advantages of taking out a USDA loan.
1. No down payment
For many people, the thought of scraping together a down payment is the biggest barrier to buying a home. But with a USDA loan, there’s no down payment required. In comparison, you’ll need a 3.5% down payment for an FHA loan and a minimum 5% down payment for a conventional mortgage.
2. Low private mortgage insurance (PMI)
Anyone who buys a home with no down payment is required to purchase private mortgage insurance (PMI). The costs vary, but in general, PMI costs between 0.5% to 1.0% of the total loan amount.
When you take out a USDA mortgage, you won’t get out of purchasing PMI, but the rates are lower than if you go the conventional financing route.
3. Low credit requirements
USDA loans also come with more flexible credit requirements than what other lenders look for. If your credit score is at least 640, your application should be approved pretty quickly. And the program is available for borrowers that are short on credit history.
4. Finance your closing costs
When you buy a home, the lender charges closing costs for issuing the loan. The closing costs usually fall between 2% and 5% of the total loan amount. So if you buy a $200,000 home, you can expect to pay at least $4,000 in closing costs.
When you take out a USDA loan, you can roll your closing costs into the loan financing. This means you can finance your closing costs instead of paying them out of pocket.
How do you qualify for a USDA loan?
Taking out a USDA loan doesn’t mean you have to move to the middle of nowhere. There are a wide variety of properties eligible for purchase through the USDA loan program.
While you won’t find any homes located in a major metropolitan area, you may be able to find some in certain suburban areas. Of course, the biggest selection is available in rural areas since the purpose of the program is to strengthen these communities.
To find out if a home you’re interested in qualifies, simply input the address into the USDA website. The USDA does have strict requirements the home must meet to qualify for the program, which we’ll discuss in more detail below.
USDA Loan Requirements
Here is an overview of the borrower requirements for the USDA loan program:
- You must be a U.S. citizen, non-citizen national, or qualified alien
- The home must be located in an eligible location
- You must be purchasing the home as your primary residence
- The loan must be taken out through a USDA-approved lender
- You must be able to meet the minimum credit requirements
This program is designed to help low to middle-income families, so there are certain income limitations borrowers must meet. To qualify, your household income cannot exceed 115% of the median income in your area.
The income requirements are determined by county, so you can check the USDA’s website to find out what the requirements are in your area. You can also work with a USDA-approved lender to determine your eligibility.
The U.S. Department of Agriculture also puts certain restrictions on the type of property you can buy with a USDA loan. Here are the types of properties that are eligible for a USDA loan:
- Single-family homes
- New construction homes
- Townhomes and approved condos
- Planned Unit Developments
- Approved modular homes
Three Types of USDA Home Loans
There are actually three types of home loans available through the USDA. Here’s a quick breakdown of each one.
1. Guaranteed Loans
Guaranteed loans have the broadest eligibility requirements and are backed by the USDA, but are originated and serviced by a mortgage lender. A down payment isn’t required, but you will have to pay PMI if you put down less than 20%. Homebuyers in this program can also qualify for low interest rates.
2. Direct Loans
Buyers who are considered to be in the low-income category may qualify for a direct loan. Interest rates can go as low as 1% with certain subsidies.
3. Loans and Grants for Home Improvement
If you already own an eligible property and meet the income requirements, you could qualify for home improvement funding from the USDA. You could receive a loan for up to $20,000, and the repayment terms and very favorable. Grants for up to $7,500 are also available.
What credit score do you need for a USDA loan?
If you’re applying for a guaranteed USDA loan, there are a few basic credit requirements you’ll need to meet. The USDA doesn’t set a minimum credit score requirement, but if your credit score is at least 640, your application will get processed much faster.
A credit score below 640 doesn’t automatically rule you out, but your application will go through stricter underwriting guidelines. This is to ensure you can handle the monthly mortgage payments.
And you’re less likely to be approved if you’ve been sent to collections over the past 12 months. You may be granted an exception if you can prove that your credit was damaged because of a medical issue or something outside of your control.
And finally, a USDA loan may be a good option for you if you’re still in the process of building your credit score. If you can supply other credit references, like utility payments or rent payments, your application may be approved even if you have limited a credit history.
USDA Income Limits
In order to make sure the USDA loan program benefits low to middle-income families, there are income limits set on all USDA loans. These income restrictions are determined by a variety of factors, including the median income for your local city or county. You can check your income eligibility to find out if you qualify.
The size of your family also helps determine your eligibility. If you have a large family, then it’s expected you’ll need a more substantial income to live on, and you’ll receive more leeway.
There are also different tiers of eligibility, depending on the type of USDA loan you’re taking out. Guaranteed loans call for a moderate income, whereas direct loans require applicants to fall in the low-income category.
Finally, you must have a stable monthly income in order to be eligible for a USDA loan. Usually, you need to show a history of stable employment for at least 24 months.
If you have questions about your eligibility, you can contact a mortgage lender that specializes in USDA loans. Just be sure to ask, so you don’t waste your time working with a lender who doesn’t understand the nuances of USDA loans.
Real estate agents that work in a rural area may also be able to point you in the right direction since they’re likely to have more experience with clients utilizing these programs.
Are there any other eligibility requirements?
This article is mostly focused on the USDA’s requirements, but keep in mind, the USDA isn’t lending you any money. Each lender can apply its own requirements as long as they meet the USDA’s basic guidelines. Your lender will want a complete financial picture, as well as your credit history and current employment status.
And one of the guidelines surrounds PITI, which stands for principal, interest, insurance, and taxes. Each of these things are combined to form your total monthly mortgage payment.
This amount can’t be more than 29% of your pre-tax monthly income. So if you make $3,000 per month, your total monthly payment would have to be less than $900.
Another common requirement is known as your debt-to-income ratio. This is when the lender looks at compares your income to your total monthly debt payments. Ideally, your debt-to-income ratio shouldn’t be higher than 41%.
So if your income is $3,000 per month, then your total monthly debt payments should be less than $1,230. And remember, your mortgage will be included in the total debt payments. But you may qualify for a higher debt ratio if your credit score is higher than 680.
With a USDA mortgage, you can purchase your dream home without having to save up for a down payment. However, not everyone will qualify for this program.
If you’re interested in taking out a USDA loan, you should start by finding out if you meet the income restrictions in your county. And you might consider working with an experienced USDA lender to find out if you’re a good candidate for the program.