USDA Loans – How Do They Work?

USDA Loans - How Do They Work?Thinking of getting on the housing ladder? Looking to buy in a rural or suburban area?

If so, a USDA home loan could be a great option –or at least, something that’s worth considering.

USDA loans, sometimes called USDA Rural Development Guaranteed Housing Loans –are a type of loan that offers a number of benefits; making them an ideal choice for those who qualify. For one thing, USDA loans offer 100% financing, which means you won’t need to secure funds for a down payment. Additionally, these loans can be obtained even if your credit score isn’t that great.

To qualify, though, there are a number of requirements that will need to be met. First up, your income will need to fall within a specific bracket. The property in question will also need to be located in a rural or suburban area. Additionally, the property itself must meet specific criteria as well.

If you’re looking into mortgages, a USDA loan could be a great option, but they’re not right for everyone. With this in mind, let’s take a look at some of the benefits of these loans –and see whether this loan is something you should consider.

What Is a USDA Home Loan?

A USDA Home Loan is a mortgage that’s backed by the U.S. Department of Agriculture.

With a name like this, you might think that USDA loans are only for farmers, but the truth is, USDA loans aren’t designed for farms or any commercial property. Instead, they’re only suitable for homes that are purchased as a primary residence –so rental properties wouldn’t qualify either.

And despite their name, you don’t have to live in a remote rural area in order to qualify. In fact, these loans are designed for homebuyers who live in rural –or even suburban areas across the country. According to the USDA guidelines, eligible areas must have a population of less than 35,000 –and there are a number of areas that qualify for these loans.

In fact, an estimated 97% of the U.S. is eligible for this loan!

This means that unless you’re planning on living in a major metropolis, there’s a good chance that your location could qualify.

Tip: Use this USDA eligibility checker to see if your area qualifies. Just type in an address to see if the property that you’re considering is eligible.

USDA Loans are good for familiesWho Are They For?

The USDA created this program to help families who don’t have a lot of options, but this type of loan is something that many people could be eligible for. And, thanks to the low down payment requirements, along with a few other key benefits, they’re an option that may be worth pursuing.

First of all, the property will need to be your primary residence and must be owner-occupied. So you cannot use this loan to buy a vacation home or rental property.

It’s also worth noting that the USDA issues mortgages to applicants that are deemed to have the greatest need. So individuals or families must be:

  • Without decent, safe and sanitary housing
  • Unable to secure a home loan from traditional sources
  • Have adjusted income that is at or below the low-income limit for the area where they live

Why Was The USDA Program Created?

This program is designed to help invigorate rural areas, by providing low and moderate-income households with the opportunity to own an adequate, decent, safe, and sanitary dwelling.

In 2017, the USDA helped some 127,000 families to buy or upgrade their homes.

By offering 100% financing to eligible buyers in areas of the country that are less densely populated, this program is encouraging homeownership; something that leads to stable communities, and in turn, helps to encourage economic development in these areas.

Benefits of a USDA Loan

USDA loans offer a number of benefits that make them ideal for many.

Here’s a look at some of the main ones now:

  • No Down Payment Required

One of the main things that make these loans a popular option is that they require no money down. Applicants can obtain financing with a 0% down payment.

  • Not Limited to First-Time Homebuyers

Although USDA loans are ideal for first-time buyers, thanks to the fact that they don’t require a down payment, they’re not limited to first-time buyers, repeat buyers are also eligible.

  • Fixed-Rate Terms

USDA loans have fixed 30-year, or 15-year, interest rates. The lender and applicants will agree to the rates before closing.

This is in contrast to variable interest rate loans, where interest rates are subject to change at any time. This type of financing can be risky should interest rates go up in the future.

  • Allows Seller Concessions 

These loans also allow for seller contributions to closing costs.

USDA loans are designed for homebuyers who live in rural –or even suburban area across the countryUSDA Loan Limits 

As mentioned above, these loans are a great way to get your foot on the housing ladder, but limitations do apply. So if you have your heart set on a sizable home with a pool, this loan will not be suitable.

Generally, USDA loans are for homes that are less than 2k square feet or less; homes with a market value that’s below the area loan limit. This limit will depend greatly from market to market –in some pricy areas, it could be as high as $500,000, while it could be as low as just over $100,000 in some rural markets.

Different Types of USDA Loans

There are three different kinds of USDA home loans.

Let’s take a look now:

  • Direct Loans (Section 502 Direct Loan Program): With this loan, the USDA directly loans to low-income borrowers. In addition to buying a home, the funds can also be used to build, renovate, repair, or even relocate properties in eligible areas. With this loan, interest rates can be as low as 1%.

Properties financed with direct loan funds must:

  • Generally, be 2,000 square feet or less
  • Not have a market value that exceeds the applicable area loan limit
  • Not have an in-ground swimming pool
  • Not be designed for income-producing activities
  • Guaranteed Loans: With this program, approved lenders can generate the loans, but the USDA provides a guarantee, up to 90%. This makes it somewhat easier to get a home loan with 0% down, even if your credit isn’t perfect. However, you will have to pay a mortgage insurance premium in these cases.

Additionally, the income limits for this program are a bit higher than with the 502 direct loan program.

  • USDA Housing Repair Loans – Section 504 Loans: With this program, recipients can obtain a loan up to $20,000, or grants up to $7,500 for the elderly. This loan is designed to help very-low-income homeowners to repair or modernize their homes, or to remove health or safety hazards. These loans can also combine both a loan and a grant to offer up to $27,500 in financial assistance.

In 2017, the USDA helped some 127,000 families to buy or upgrade their homes.USDA Rural Development Loan Eligibility

Next up, let’s take a look at a few eligibility requirements for properties.

First of all, the property in question must be your primary home, not a second home or a rental property. The property also can’t be a working farm.

USDA loans are contingent on the property meeting very specific criteria –meaning that if you’re thinking of buying a fixer-upper or say, looking for a property with a pool –you’ll want to look elsewhere. USDA loans are designed to provide options for people in areas that lack decent housing options and are for people who are looking for modest, decent homes.

Your home appraisal will need to show the condition of the home meets USDA standards.

This includes the following:

  • Water, electrical, heating, cooling systems must be up-to-date and working
  • The foundation and house will need to be structurally sound
  • The property must be accessible via a paved or all-weather road

In addition to the property requirements, here’s a look at some more key requirements for USDA loans.

  • Citizenship: You must have U.S. citizenship or permanent residency.
  • Income: You must be able to reach certain income requirements. You’ll need to show you’ve had reliable income for at least two years. You also need to prove that your income falls below a certain threshold –this amount varies by region and occupants.

Generally, your income must fall within the following limits for most areas:

  • 1-4 family members: $74,750
  • 5-8 family members: $98,650
  • Credit History: A credit score of 680 or higher means that you may qualify for streamlined loan processing. However, even if your credit score is low, you may still qualify. You must also not have had any collections over the last year.
  • Debt Ratio: You’ll also need to have a debt ratio of 41% or less unless you have a credit score of 680 or higher. If your credit score is 680 or less, then your repayments must not be more than 29% of your monthly income.

You must also:

  • Agree to occupy the dwelling as your primary residence
  • Have the legal capacity to incur the loan obligations
  • Have not been suspended or debarred from participation in federal programs
  • Demonstrate a willingness to meet credit obligations in a timely manner

USDA Loan Fees

With most loans, mortgage insurance (PMI) is required because every lender wants to be able to protect themselves in case you’re unable to repay your loan. While USDA loans don’t officially require PMI, they do have other fees that work in a similar way.

USDA loans have a fee of 1% that’s payable throughout the lifetime of the loan. Since 2019 the USDA also charges a 0.35% annual fee on the loan amount. This fee must be paid off over a 12-month period. These fees can add an increase to your payments so make sure you’ll be able to pay it before you close on this loan.

Unless you’re paying 20% down, you won’t be able to avoid these fees.

At the end of the day a USDA loan offers a number of key benefits that make it a great option for many people who are looking to buy in rural or suburban areas.

Your best option is to talk with mortgage providers to see what type of loans you’d qualify for. Don’t be afraid to shop around. Different lenders have different lending standards and requirements so make sure you check with a few different lenders to see what your options are, and to find a loan that will benefit you the most. Check out this list of USDA mortgage lenders to get started.

Note: This information is intended to inform and guide but it is not meant to serve in place of advice from a professional lending agency. Please consult with a lender first to learn more about obtaining a mortgage and to see what terms you qualify for.

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