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What Is a USDA Loan?

tl;dr

What You Need To Know

  • If you want to build, buy or renovate a home in rural America, a USDA home loan is a great option that requires 0% down
  • To qualify for a USDA home, you need to meet home location, income and credit score eligibility requirements
  • A surprising range of homes are eligible for a USDA loan as long as the home is your primary residence

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Feeling cooped up in your metro area? You’re not alone. 

According to recent Census data, 86% of U.S. residents live in metro areas. That leaves 14% of the population spread out in the rural areas of the country – which spans 72% of the nation’s land area.[1]

So, if you’re looking for more space, there is plenty of it for home buyers who want to move to America’s rural areas.

Now, rural doesn’t mean that you have to live on a farm or be the only home for miles around. 

If it ain’t urban, it’s rural. Even an area with up to 50,000 people is considered rural as long as it’s not part of a larger metropolitan area.[2]

So, if the idea of small towns and open spaces appeals to you, the U.S. Department of Agriculture (USDA) has likely got a loan for that. 

The USDA does a lot more than grade America’s beef and oversee the quality of its produce. The agency is also in charge of maintaining the vitality of rural communities. 

To do that, the USDA offers USDA home loans and loan programs that help you buy, build, repair or renovate a home in one of America’s many rural communities.

So, if you want to make a move and bid farewell to the city and the ‘burbs, a USDA home loan might help you do just that.

How Does a USDA Loan Work?

USDA loans (like Department of Veterans Affairs (VA) loans and Federal Housing Administration (FHA) loans) are mortgage loans that are backed by the U.S. government. While they work like any other kind of mortgage loan, USDA loans have unique benefits and eligibility requirements.

How Do I Apply for a USDA Loan?

Just like an FHA or VA loan, most borrowers can get a USDA-guaranteed loan through banks, credit unions or other mortgage lenders. Like any mortgage, you work with a loan officer, you go through underwriting and closing, and then you make monthly mortgage payments to the lender.

The USDA doesn’t directly lend you the money. Instead, it guarantees the loan up to 90%, making it easier for lenders to offer more families home loans.

The USDA makes it easy to comparison shop for lenders, providing a list of approved lenders that range from local banks and credit unions to national banks and online lenders.

And you can do more than buy a house. There are USDA loans that allow you to build your own home or refinance your current mortgage.

What Are the Benefits of a USDA Loan?

USDA loans offer lots of the same benefits as other government-backed loans, but with less baggage. 

To start, USDA loans have no down payment requirement. 

In comparison to FHA loans, USDA loans offer lower interest rates and lower fees. And you can borrow extra money for home upgrades. Like FHA loans, you can get down payment assistance from a wider variety of sources than you could for conventional loans.

Let’s look at these USDA loan benefits in detail.

No down payment required

For many home buyers, especially first-time home buyers, saving enough for a down payment can be a major obstacle to homeownership.

With a USDA loan, the down payment isn’t a problem because down payments aren’t required. You’re still responsible for closing costs, but you can have the costs folded into your mortgage loan.

Low interest rates

USDA loans usually offer some of the lowest interest rates available and are competitive with conventional loan interest rates.

Borrowing more than the purchase price

Another USDA loan benefit is that you can borrow up to 100% of the home’s appraised value. That means you can borrow more than the money you need to buy or build a home. You can also borrow money to cover related expenses, including:

  • Closing costs: This includes lender fees and other expenses related to closing on the property.
  • Connection fees: This involves getting the home hooked up to utilities, including water, sewage, electrical and even broadband.
  • Setting up an escrow account: You can put money down to cover real estate taxes, hazard and flood insurance premiums.
  • Accessible equipment and furniture: You can use the money to install features, like ramps and guardrails, that are part of the house.
  • Essential household equipment: An item is essential if you can’t take it with you when you move. This includes wall-to-wall carpeting, large kitchen appliances, washers, dryers and heating and cooling equipment.
  • Energy efficiency measures: This includes the installation of double-paned windows, insulation and solar panels.
  • Site preparation: This includes improvements that permanently enhance the value of the home, like grading, foundation plantings, seeding or sod installation, trees, walkways, fences and driveways.

Take advantage of gift funds

Like FHA loans, USDA loans let you take advantage of gift money for down payments and down payment assistance programs from a wide range of sources, including:

  • Family members (including extended family, domestic partners and fiances)
  • Employers or labor unions
  • Charitable organizations
  • Homeownership assistance grants and programs

Are There Limitations on a USDA Loan?

USDA loans have lots of benefits … and requirements. 

Credit score

For most lenders, a credit score of 640 or higher is preferred. Lenders can offer loans to borrowers with lower credit scores or limited credit history at their discretion.

Debt-to-income (DTI) ratio 

Your DTI takes all of your monthly debts (think: minimum monthly credit card payments, rent or mortgage, student loans, auto loans and personal loans) and divides them by your monthly gross income.

To qualify for a USDA loan, you need a DTI of 41% or less. This is a little less forgiving than an FHA loan, which can allow for a DTI of 57%.

Income limit

The program is designed to help low- and moderate-income home buyers. You’ll have to check and see if you meet the USDA’s income-eligibility requirement. The income requirements vary because they are based on area. Your income can’t exceed 115% of the median household income (MHI) in the area where you want to live.

What Type of Property Is Eligible for a USDA Loan?

The home you plan on buying or building needs to be in an eligible rural area. You can check the USDA website to see if the property qualifies.

The home must be your primary residence and a single-family home. BTW, single-family homes come in all structures and styles, everything from McMansions to cabins to townhouses. The home can also be part of a planned unit development (PUD) or a condo complex. What it can’t be is a vacation home or investment property. 

There is no maximum purchase price or acreage limit. You can buy it as long as:

  • You can afford the property.
  • The property is similar in price and square footage in comparison to other homes in the area. 
  • It meets the Department of Housing and Urban Development’s (HUD) standards for health and safety.

Also, there is no flipping allowed with a USDA loan. You shouldn’t expect to add “USDA Prime Flippers” to your binge-watch list any time soon.

Country Roads, Take Me Home

If you’re thinking about a fresh start and a new home “where the deer and the antelope play” – or at least used to play – a USDA loan can be a great option. You get competitive interest rates. You can skip the down payment. And if you need it, you can borrow the extra money you’ll need to get your home up and running.

  1. USDA Economic Research Service. “Nonmetro population change has remained near zero in recent years.” Retrieved September 2021 from https://www.ers.usda.gov/data-products/chart-gallery/gallery/chart-detail/?chartId=99693

  2. U.S. Census Bureau. “Defining Rural at the U.S. Census Bureau.” Retrieved September 2021 from https://www.census.gov/content/dam/Census/library/publications/2016/acs/acsgeo-1.pdf

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In Case You Missed It

Take-aways

  1. USDA loans offer some of the lowest upfront and annual fees for government-backed loans
  2. Think beyond the farmhouse. Use a USDA loan to buy a condo or a home in a planned community
  3. With a USDA loan, you can borrow additional money for home upgrades, including utilities, broadband and accessibility improvements

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