A USDA loan is a mortgage for homes in rural or suburban counties, and you don’t need any money for a down payment. A USDA Loan is designed for individuals with low-to-moderate incomes who are purchasing a home in rural or suburban areas of the United States.
These mortgage loans do not requires any down payment, although a minimum credit score of 640 is typically required. Additionally, homes located in rural areas or counties with populations of 20,000 or fewer residents may be eligible for a USDA loan.
This guide will explain what is a USDA loan, types of USDA Mortgage. It will talk about who eligible for a USDA loan in United States, the pros and cons of a USDA loan.
What is a USDA loan?
A USDA loan is a type of mortgage supported by the United States Department of Agriculture, aimed for people with low-to-moderate income levels who are buying homes in rural or suburban regions. In most cases, these people are buying homes for the first time.
United States Department of Agriculture (USDA)
The United States Department of Agriculture (USDA) is a federal executive department of the U.S. government. It is responsible for various aspects of agriculture, rural development, and food safety. Established in 1862, the USDA’s mission encompasses promoting agricultural trade, ensuring food security, conserving natural resources, supporting rural communities, and fostering the overall well-being of American citizens.
There are two primary types of USDA home loans:
- Guaranteed: This type is supported by the USDA, and the application process is done through a participating lender.
- Direct: The USDA directly provides the loan, requiring direct application with the USDA.
USDA Direct loans target lower-income borrowers and have more stringent criteria. Typically, when people mention a USDA loan, they are referring to a guaranteed loan, specifically the USDA Rural Development Guaranteed Housing Loan Program — and this is the type of USDA loan that we are exploring in this article.
The advantage of a USDA loan is the ability to purchase a home without making a down payment. However, it’s important to note that only fixed-rate mortgages are available; adjustable rates are not an option for USDA loans.
Types of USDA Mortgage
Below is how a USDA loan is different than other types of mortgages. However, there are two primary categories of mortgages: conventional loans and government-backed loans.
A conventional loan is not backed by the government. It is granted by private lenders like banks or credit unions without government insurance. However, you can opt for a conventional mortgage supported by government-sponsored lenders such as Fannie Mae or Freddie Mac. These mortgages requires a credit score of at least 620, a debt-to-income ratio of 36%, and a down payment ranging from 3% to 10%.
On the other hand, a government-backed loan is backed by a federal agency. If you fail to meet your mortgage obligations, the agency covers the lender on your behalf. When a lender extends a government-guaranteed mortgage, it’s akin to obtaining insurance on your loan. It’s generally easier to qualify for a government-backed mortgage compared to a conventional one.
Among government-backed loans, the USDA Rural Development Guaranteed Housing Loan stands out due to more lenient eligibility criteria.
What are the 3 Types of government-backed Mortgage
There are three main types of government-backed mortgages: FHA, VA, and USDA loans, each with distinct characteristics:
- FHA loan: A Federal Housing Administration mortgage is not restricted to a specific group. You may qualify with a down payment as low as 3.5%, a debt-to-income ratio of 43%, and a credit score of 580.
- VA loan: A Veterans Affairs mortgage targets active or retired military members. While many lenders require a credit score of 660 and a DTI of 41%, no down payment is necessary.
- USDA loan: This loan type is designed for low-to-moderate income borrowers purchasing homes in rural or suburban areas of the US. While a credit score of at least 640 and a DTI of 41% are recommended, no down payment is required.
Who is eligible for a USDA loan in United States?
When checking your eligibility for a USDA loan, a lender carefully examines two factors, namely the type of property you intend to buy and your financial profile. They also take into account various aspects of your income, credit history, and debt obligations. Let’s discuss them one by one.
1. Property eligibility
If you are in the process of purchasing a home situated in a rural or suburban locale, you could potentially meet the criteria for eligibility for a USDA loan. These eligibility parameters are contingent on the population thresholds, which stipulate that certain counties have a population limit of 20,000 while others can extend up to 35,000.
Should you already possess the address of the intended property you wish to acquire, you have the option to input this information into the USDA Property Eligibility Site. Within this interface, you will be prompted to designate the specific category of USDA loan that aligns with your interest. For instance, if you are considering a guaranteed USDA loan, you will select the “Single Family Housing Guaranteed” option.
2. Borrower eligibility
In order to meet the requirements for a USDA loan, several factors or criterias has to be met:
- Citizenship or Residency: You are required to be a United States citizen or a permanent resident.
- Income Level: Your household’s income should fall within the low-to-moderate range. The specific maximum income threshold is contingent upon your geographical location, which can be ascertained by referring to the income limit designated for your county.
- Stable Income: Demonstrating a consistent and stable income for a minimum of the last two years is necessary.
- Credit History: A favorable credit history is essential. While many lenders stipulate a credit score of 640 or higher, exceptions might apply.
- Affordability Ratio: Your monthly mortgage payments, encompassing loan principal, interest, insurance, taxes, and homeowner’s association dues, should not surpass 29% of your monthly income.
- Debt-to-Income Ratio: Your additional debt payments should equate to 41% or less of your monthly income. Notably, a higher debt-to-income ratio may still allow qualification if you possess a notably high or excellent credit score.
- Maximum Borrowing Limit: Unlike conventional mortgages, there is no predefined maximum borrowing limit for USDA loans. Lenders will assess your financial profile and approve a borrowing amount accordingly.
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The pros and cons of a USDA loan
A USDA loan suite your needs, but it’s important to understand the advantages and disadvantages of USDA loan. Here’s a breakdown of the pros and cons of choosing for this type of mortgage:
Pros of USDA loan
Here are some positive aspects of choosing a USDA loan:
- Low and Favorable Interest Rates: Typically, USDA loans offer lower interest rates compared to conventional, FHA, or VA mortgages. If you have excellent credit, a low debt-to-income ratio, or contribute a down payment, you might secure an even more attractive rate.
- Zero Down Payment: Except for VA loans, which are exclusive to military-related borrowers, USDA loans are unique in not requiring any upfront payment. This makes it a feasible option for individuals with limited savings.
- Affordable Insurance Costs: While USDA loans involve mortgage insurance expenses, these costs are relatively lower than those associated with other mortgage types. You’ll pay 1% of the principal at closing, along with an annual premium of 0.35% of the remaining principal. In contrast, FHA loans necessitate a 1.75% mortgage insurance premium at closing, coupled with an annual premium ranging from 0.45% to 1.05% of the mortgage amount. Conventional loans often require private mortgage insurance until achieving 20% to 22% equity, which could be time-consuming and costly without a substantial down payment.
- Refinancing Options: If you later decide to pursue refinancing for reduced monthly payments or a more favorable interest rate, you can opt for another USDA loan as part of the process.
These benefits can make a USDA loan an attractive choice for eligible borrowers.
Cons of USDA loan
Here are some important considerations to keep in mind when it comes to USDA loans:
- Location Restrictions: USDA loans are specifically designed for individuals purchasing homes in rural and suburban areas of the US. Properties in urban or densely populated areas with more than 35,000 residents may not meet the eligibility criteria for a USDA loan.
- Income Limits: To qualify for a USDA loan, your household income should fall within the low-to-moderate income range, which varies based on your county of residence.
- Fixed-Rate Only: USDA loans exclusively offer fixed-rate mortgages. Adjustable-rate loans are not available under this program.
- Single-Family Homes: USDA loans are intended for the purchase of single-family homes. If you’re interested in acquiring a multi-family property, an FHA loan might be a more suitable option.
- No Cash-Out Refinances: While you can refinance a USDA loan, it’s important to note that cash-out refinances, which allow you to access cash by leveraging your home equity, are not an option with this type of loan.
Understanding these limitations will help you determine if a USDA loan aligns with your specific homeownership goals and financial situation.
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