- USDA loans are government-backed mortgages for buying homes in less-populated areas.
- USDA loans are zero-down mortgages for people with low-to-moderate incomes.
- You can use USDA loans to buy or refinance an eligible property if you qualify.
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Seeking an opportunity to purchase an affordable home in a non-urban location? USDA loans can provide the financing you need with no money down and at a relatively low interest rate.
You may be wondering: how do USDA home loans work? It’s essential to understand what’s involved with getting a USDA loan, including income limits for USDA home loans, your required credit score for USDA home loans, and how to apply for USDA home loans. Read on for answers and tips.
How Do USDA Loans Work?
A USDA loan is a government-backed loan designed to stimulate growth and prosperity in rural and small-town areas. USDA loans offer low-interest financing with no down payment required, enabling Americans who cannot qualify for traditional loans to purchase a primary residence.
“The USDA loan is often referred to as a Rural Development Loan or Section 502 loan because it is part of the government’s Rural Development program. Their goal is to improve the quality of life in rural areas and small towns,” notes Jason Gelios, a Realtor in Southeast Michigan.
Alexandra Rodriguez-Howell, director of Silverton Mortgage in Atlanta, explains that Section 502 loans are intended to help low-and very-low-income applicants purchase decent, safe, and sanitary housing in eligible rural areas by providing payment assistance to increase an applicant’s repayment ability.
“It is a type of subsidy that reduces the mortgage payment for a brief time and is determined by the adjusted family income,” she says.
What Are the Pros and Cons of USDA Loans?
There are many advantages to getting a USDA loan. Among the perks:
- Zero down payment requirement
- Competitive interest rates
- No cash reserves required
- Flexible credit guidelines
- No loan limits apply
However, there are some caveats, including:
- Geographic restrictions apply, as the home must be located in a rural area designated by the government. These include locations hosting a population of 10,000 or less in areas that are in open country or rural in character, and locations hosting a population of 20,000 or less and not situated in a Metropolitan Statistical Area (MSA). To locate a home that qualifies for USDA loan financing, click here and search the USDA home loan map.
- Income restrictions apply (more details below).
- You must use the home you purchase as a primary residence. It cannot be used as a second home or investment property.
- It must be a single-family home, not a multifamily property.
- The home must offer between 400 and 2,000 square feet.
- The property must pass an appraisal that abides by USDA property guidelines.
“Perhaps the biggest drawback is that those who want to apply for USDA loans will have to give up living in a metropolitan area. They also must not use their home for income-producing activities like short-term rentals,” says Dan Belcher, a real estate broker and CEO/founder of Mortgage Relief.
Income Limits for USDA Loans
Your household income must be equal to or less than 115% of the median income in the area to qualify for USDA financing. To find out if you are eligible for a USDA loan based on earnings, access the USDA income eligibility calculator here.
Additionally, Gelios explains that you must have a stable income source, proof of income for a minimum of 24 months, a minimum 640 FIFO credit score, a good credit history, and a debt-to-income (DTI) ratio no higher than 41%. (You can calculate your DTI by adding your total monthly debts and dividing by your gross monthly income.)
“Also, your monthly mortgage payment must be 29% or less of your monthly income,” Rodriguez-Howell continues.
Furthermore, you have to be a U.S. citizen, a permanent resident, or a foreign national.
While private mortgage insurance (PMI) is not required, USDA loan borrowers must pay two different forms of mortgage insurance: an upfront guarantee fee paid at closing (but which you can roll into your loan amount), and an annual fee that functions as the monthly mortgage insurance premium.
“The upfront fee typically equates to 1.0% of your loan amount, and the annual fee equates to approximately 0.35% of your loan amount. Let’s say you borrow $200,000. That means you could pay an estimated $59 per month in mortgage insurance,” adds Gelios. “The good news is that USDA mortgage insurance premiums are lower than what is charged for other types of loans that require mortgage insurance.”
However, “both mortgage insurance fees are required, regardless of whether or not you make a down payment,” says Rodriguez-Howell.
Keep in mind that mortgage insurance doesn’t protect you – it’s in place to safeguard the lender if you default on your loan.
Who are good candidates for pursuing USDA loans?
Good prospects for USDA loan financing include low- and middle-income families who want to live in rural areas and meet the loan requirements but may lack the money for a down payment, per Rodriguez-Howell.
Steer clear of a USDA loan, on the other hand, if you aren’t looking for a single-family home, desire a vacation or second home, seek to become a landlord, or want to run a business out of your home.
Alternatives to USDA loans
A USDA loan isn’t your only financing option. Instead, you can pursue a conventional, FHA, or VA loan.
Unlike USDA loans, conventional mortgages aren’t guaranteed or insured by the federal government.
“A down payment of at least 3% is required for a conventional loan. If the down payment is below 20%, private mortgage insurance is required, and the interest rate charged may be higher than if you had put 20% down,” says Rodriguez-Howell.
But with a conventional loan, you can purchase just about any type of property anywhere in the United States.
A USDA loan is similar to an FHA loan, except that the latter doesn’t require purchasing in a designated rural area.
“With an FHA loan, you’ll need a down payment of at least 3.5% if your credit score is 580 or higher, and a 10% minimum down payment if your credit score ranges between 500 and 579,” Rodriguez-Howell points out.
FHA loans, like USDA loans, require an upfront mortgage insurance premium and an annual mortgage insurance premium that must be paid for the life of the loan.
You must be an honorably discharged veteran, active-duty military member, or surviving spouse to be eligible for VA home loans. If you qualify, you can get home financing for zero down and with no mortgage insurance required, with no location requirements, no income limits, and a low interest rate. VA loans represent possibly the best mortgage financing deals around, but you have to be a qualified applicant.
How to Apply for USDA Loans
“USDA loans are only offered by lenders approved by the USDA to offer this type of financing,” says Gelios. “These approved lenders are not hard to find, as they are often represented by local retail banks, credit unions, or mortgage brokers.”
Applying for a USDA loan is similar to any other type of mortgage loan. You can apply online or in-person at a participating lender’s brick-and-mortar location.
The process of applying and receiving financing for a USDA loan typically involves completing an application for preapproval from a USDA-approved lender, locating a USDA-eligible property, signing a contract/purchase agreement, waiting as your loan is processed and underwritten, and closing on your USDA loan.
What is the required credit score for USDA home loans?
You’ll need at least a 640 FICO credit score to qualify for a USDA home loan. Your chances of getting approved increase if you have a higher credit score.
Is mortgage insurance required for USDA loans?
Yes. You must pay two forms of mortgage insurance with a USDA loan. The first is an upfront guarantee fee (approximately 1.0% of your loan amount) paid at closing; the second is an annual fee (approximately 0.35% of your loan amount) that serves as a monthly mortgage insurance premium. These fees are required whether or not you make a down payment on a USDA loan.
Who offers USDA home loans?
Specific lenders approved by the USDA offer USDA loans, including retail banks, credit unions, and mortgage brokers. You can apply for a USDA loan with these lenders online or in person at a brick-and-mortar location, depending on the lender.