USDA Loans | A Complete Guide
A USDA home loan is one of the most flexible mortgage programs available, even if very few people know anything about it. These loans cover the entire purchase price of the home, resulting in a zero down payment arrangement for the buyer.
100% financing arrangements were quite popular prior to the 2008 Housing Crisis. Not only were they being offered as conventional mortgages, but it was also possible to do a zero down loan with an FHA mortgage, in combination with local government down payment grants.
Due to the high default rate, 100% financing disappeared for conventional mortgages. They’re still available for FHA mortgages with local government grants. But the primary 100% mortgage available today is the VA mortgage.
Or is it?
USDA loans, which is an abbreviation for the United States Department of Agriculture, are also available to provide financing up to 100% (or more) of the purchase price of a home. These loans are not available for homebuyers and homeowners in all situations, but they are more commonly available than most people think.
What Is A USDA Loan?
USDA home loans are designed to be used specifically in rural areas of the country. However, the loan program is quite generous in its definition of rural. It takes in a surprising number of counties throughout the US that many would consider as suburban.
Approximately 97% of counties throughout the US are considered eligible for USDA loans. In fact, the only counties not categorically included in the USDA program are those that are certifiably urban in nature (think the five boroughs of New York City).
The USDA program provides a 90% loan guarantee to approved lenders. That means if a mortgage goes into default, the maximum loss the lender will experience is 10% of the outstanding loan balance. This is a powerful incentive for lenders to make USDA loans under significantly relaxed criteria.
Much like FHA and VA loans, which are similarly government-sponsored mortgage programs, USDA loans are available through many different mortgage lenders, particularly mortgage banks and brokers. However, they can also be obtained directly through the USDA. And unlike VA loans, USDA loans are not restricted to eligible veterans alone.
USDA Loan Requirements
Like all other major mortgage loan programs, USDA loans have specific guidelines. These requirements relate primarily to borrower and property eligibility.
USDA Loan Eligibility
USDA loans have particular borrower requirements. These include:
- You must qualify as a low- or moderate-income household based on income limits in your county of residence. This is defined as a household income not to exceed 115% of the median household income for that county.
- You must be without decent, safe, and sanitary housing.
- The subject property must be a primary residence.
- The property must be in an eligible county.
- The borrower must be a US citizen, a non-citizen national, or a qualified alien.
- The borrower cannot be suspended or debarred from participation in federal programs.
Down Payment Requirement
As a general rule, USDA loans do not require a down payment. However, the program does specifically require that applicants with assets higher than the asset limits permitted under the program may be required to use a portion of those assets toward the down payment.
For streamlined credit analysis, USDA loans require a minimum credit score of 640. There must also be no outstanding federal judgments, no significant delinquencies, and no “do not pay matches” to the US government on any federal debts.
However, USDA loans do have a provision for a more detailed credit analysis, apart from your credit score.
Your credit will be reviewed for up to 36 months. If you do have significant delinquencies, you’ll need to provide a valid reason for the situation, as well as evidence of steps taken to correct the problem going forward.
Lenders can refer to alternative credit sources if the borrower either lacks a credit score or has a score below 640 that’s weighed down by a lack of traditional credit. The borrower will need to supply evidence of payment on those alternative sources for between 12 and 24 months.
Alternative credit sources can include rent payments, insurance, personal loans (with terms in writing supported by copies of canceled checks), or payment for regular services, like utilities, Internet, cell phone service, and cable TV. Other alternatives can include fees to childcare providers (other than a relative), school tuition, or payments to department or furniture stores or rent-to-own arrangements.
What Credit Issues are Unacceptable for USDA Loans?
Even considering all of the above, credit will be considered unacceptable under the following circumstances:
- Little or No Credit History
- Installment accounts with delinquency in the last 12 months
- Two or more late payments of 30 days or more in 12 months
- Foreclosure in Past 36 Months
- Outstanding Tax Liens
- Two or more late rent payments within 2 years
- Outstanding collection accounts with irregular payments
USDA Loan Income Limits
To be eligible for a USDA loan, your total household income must be no more than 115% of the median household income for the county where the property is being purchased or refinanced. You can determine if you meet this requirement by using the USDA’s income eligibility calculator.
For income calculation purposes, all sources within the household are included. However, live-in aide and foster persons – both children and adults – are not considered members of the household, and payments received for the care of foster persons are expressly excluded from income sources. Also excluded is any income earned by a household member under 18 years old, and any earned income over $480 of a household member who is a full-time student, 18 years or older.
Income sources included are wages, self-employment, interest or dividends from real or personal property, Social Security benefits – including benefits received by adults on behalf of minors or by minors intended for their own support, and periodic payments from annuities, retirement funds, disability, and death payments. Also counted will be income from public assistance, child support, alimony, recurring gifts, or Armed Forces pay. The latter may include unemployment, Worker’s Compensation, severance pay, and disability compensation.
Income sources will be counted if they are expected to continue for at least the next 12 months.
Once income from all sources has been calculated, certain deductions will be applied. These will include costs incurred for childcare, and unreimbursed medical expenses (including medical, Medicare and long-term care premiums) for the elderly, and disability assistance expenses.
Both the inclusions and deductions will be used to determine income eligibility and income to qualify for the loan.
Calculating Income Adequacy
USDA loans use two debt-to-income (DTI) calculations. The first is for your proposed housing payment. Including mortgage principal and interest, real estate taxes, homeowner’s insurance, mortgage insurance, and any homeowner’s association fees due, it’s generally limited to 29% of your stable monthly income.
But your total DTI – which is your new house payment, plus recurring debts like auto loans and credit cards – is limited to 41%. However, you can exceed these ratios with substantial compensating factors.
USDA Loan Property Requirements
The USDA imposes very specific requirements for a property securing a loan. Eligible properties must meet the following requirements:
- Generally, be 2,000 square feet or less
- Not have a market value in excess of the applicable area loan limit (as described in the next section)
- Have no inground swimming pools
- Not be designed for income-producing activities
In addition, financed properties must be single-family, owner-occupied only. And in addition to using loan proceeds for the purchase of a home, they can also be used to build, repair, renovate, or even relocate a home. If a house is relocated, you can also include site preparation in the financing, including accessing water and sewage facilities.
Eligible properties include both detached and attached homes, condos, planned unit developments (PUDs), and modular or manufactured homes. In addition, there are no set acreage limits. This is in contrast to other loan programs that limit acreage primarily to lot size consistent with the surrounding neighborhood.
USDA Housing Repair Loans and Grants
USDA loans make special provisions for loans to repair, renovate or upgrade a primary residence. They can be financed with either a loan of as much as $20,000, or grants up to a maximum of $7,500. However, to be eligible for a grant, you must be at least 62 years old.
But even if you qualify for a grant, you can also get a loan. This will give you access to as much as $27,500 in total.
The funds can be used to install energy-efficient upgrades to the home, remove health and safety hazards for elderly homeowners, as well as many other improvements.
But to be eligible for repair loans and grants, you must earn less than 50% of the median income in your county of residence. You must also be unable to qualify for a loan from another source.
Put another way, while the USDA does make housing repair loans and grants available, relatively few will meet the requirements of the program.
USDA Max Loan Amounts
Unlike most other major loan programs, USDA loans don’t have a national standard maximum loan amount. The maximum is set in each county where USDA loans are available.
You can check the maximum loan limit in your county through the USDA Rural Development Single Family Housing – Area Loan Limits guide. It shows updated loan limits in every county in the country.
There are significant differences in the limits from one state or county to another. For example, the maximum loan limit for 2020 is the same in every county in Alabama, at $265,400. $265,400 seems to be the default minimum, though it can be much higher in high-priced markets.
In California, there’s a wide variation in USDA loan maximum amounts, and $265,400 is extremely rare. In a high price county like Napa, the maximum is $706,900, and $612,400 in Los Angeles County. Similar variations will occur in any state that has diverse market price levels.
Speaking of Los Angeles County, its inclusion on the USDA list of eligible counties shows how comprehensive the program actually is. As the most populous county in the US, Los Angeles County is also one of the most urban counties in the country. But USDA will still make loans available there, and at an enhanced loan amount.
Interest Rates and Fees
USDA loans are available as 30-year and 15-year fixed-rate mortgages. Unlike other major mortgage programs, they do not offer adjustable-rate mortgages.
The current interest rate on a USDA loan has been set at 3.00% for low- and very low-income borrowers, as of February 1, 2020. However, this rate is subject to change as the general interest rate environment shifts.
Interest rates on USDA loans are structured as followed:
- Fixed interest based on current market rates at loan approval or loan closing, whichever is lower.
- The interest rate, when modified by payment assistance, can be as low as 1%.
- There is a payback period of up to 33 years or 38 years for very low-income applicants who can’t afford the payments on a 33-year loan. However, you can select a shorter loan term.
Much like other mortgage types, there’s a wide range of closing costs with USDA loans. They can be anywhere from 2% to 5% of the purchase price of the property.
And when it comes to paying for closing costs, USDA loans offer borrowers more options than any other loan program. You’ll have a choice of four different options:
- The borrower can pay the closing costs out-of-pocket.
- The property seller can pay up to 6% toward closing costs for the buyer.
- If neither the borrower nor the property seller have the funds to cover closing costs, they can be added to the loan amount and financed over the loan term.
- Closing costs can be paid as a gift to the borrower from a family member or other interested third-party.
The multiple options available on closing costs – in combination with the 0% down payment requirement – make it possible for a person to purchase a home without any out-of-pocket costs at all.
USDA Loan Mortgage Insurance
USDA loans charge mortgage insurance in two ways. First, there is a 1% upfront fee, which can be added to your loan amount and financed over the loan term.
Second is the annual premium, which is paid monthly. The current rate is 0.35%, which comes to $525 per year. However, since the premium is paid monthly, it will be added to your monthly house payment, resulting in an increase of $43.75.
Mortgage insurance is not homeowner’s insurance, which reimburses you for the destruction of your property. Instead, mortgage insurance represents your contribution to the USDA to compensate the lender should you default on the mortgage. In a real way, it’s coverage for the lender – not for you as the homeowner. But this is true of all types of mortgage insurance on every loan category. Without it, lenders would not make loans to higher risk borrowers.
Pros and Cons of USDA Loans
As discussed earlier, the primary advantage of USDA home loans is that they offer 100% financing. It enables homebuyers and homeowners to obtain 100% financing to either buy or refinance their home. And even though upfront mortgage insurance – at 1% of your loan amount – is required, it can be added to the mortgage amount. In that way, you can actually finance 101% of the value of your property.
Another advantage is that USDA loans are available specifically for low- to moderate-income households. Exactly what those income limits are will depend on your county of residence.
For all the benefits they provide, these loans also have significant disadvantages. Borrowers often see “100% financing” then stop paying attention from there. That’s not a good idea when it comes to USDA loans.
Here is a summary of the Pros & Cons of USDA Loans:
- 100% financing
- Great for low- to moderate-income households
- Interest rates are often lower than conventional, FHA and VA mortgages
- The program is not limited to first-time homebuyers
- Closing costs can be covered by a gift from an interested third-party, paid by property sellers, or even added to your mortgage amount
- USDA loans can be used for new construction, to make repairs, and to make improvements on existing homes like handicap accessibility or energy-efficiency
- Higher minimum credit score requirement than conventional and FHA mortgages
- Eligibility depends on the income limits for that county
- USDA loans are not available for working farms, despite being in rural locations
- If you refinance into a USDA loan, you cannot take cash out of your property
- USDA loans can only be used for owner-occupied properties, not vacation or investment properties
- Only available in 30-and 15-year fixed-rate mortgages
Is A USDA Loan Right for You?
The USDA loan program has undeniable advantages, starting with the 0% down payment requirement, which unlike VA loans, extends to the general public. It also provides an opportunity to upgrade your home to greater energy efficiency or modification to accommodate someone who is physically impaired.
And contrary to what the public believes, the program is available in more counties throughout the United States than not. You probably live in one where the program is available.
But at the same time, the program has more limits than other popular mortgage programs. First is the income limitation. Your income cannot exceed 115% of the median household income in the county where the property is located. If it does, you won’t be eligible for the program. USDA loans also have complicated income and credit requirements that can make qualification difficult.
But if you can make the cut, it’s an opportunity to get a mortgage that may not be available from other sources, and under very favorable terms.
If you think you qualify, set up an appointment with a representative of a USDA loan approved lender to get more information as well as prequalification.