Takeaways
- USDA loans help promote homeownership in rural and suburban areas.
- A minimum credit score of approximately 640 is required for a USDA loan.
- USDA-guaranteed loans are for moderate to low-income borrowers.
- USDA repair loans and grants can assist homeowners in modernizing their homes.
- Eligibility for USDA loans depends on income, credit score, and property location.
What is a USDA Loan?
A United States Department of Agriculture (USDA) loan is a mortgage option designed to make homeownership more accessible in rural and suburban areas across the United States. Sponsored by the USDA, these loans offer significant benefits, like no down payment, reduced mortgage insurance premiums, and below-market mortgage rates.
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Contrary to most people's understanding, the USDA does not just deal with agriculture alone. The USDA also plays a crucial part in promoting rural development and ensuring that homeownership is within reach for a large segment of the American population (especially in less densely populated or rural areas). The USDA loan program aims to improve the quality of life in rural communities by providing affordable home financing options to those who meet the eligibility criteria.
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3 Types of USDA Loans
USDA loans are tailored to meet various needs, from buying a new home to making essential repairs. Knowing the differences between your options can help you better identify the one that fits your needs.
1. USDA Guaranteed Loans
USDA-guaranteed loans service moderate- to low-income borrowers who want to purchase a home in a rural area deemed USDA-eligible. Not all lenders participate in the USDA loan program. For participating lenders, the USDA guarantees these loans to reduce the financial institution’s risk and enable them to provide more favorable terms to borrowers.
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2. USDA Direct Loans
If you need more financial assistance to purchase a home because you have a low income, a USDA direct loan might be a better option than a USDA-guaranteed loan. USDA direct loans help low- and very low-income applicants who want to purchase, build, renovate, or relocate a home in an eligible rural area.
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Unlike the USDA-guaranteed loans, USDA direct loans are issued straight from the USDA and help those with the greatest financial need. Applicants can include individuals or families without decent, safe, and sanitary housing. Most USDA-direct loan applicants cannot secure a traditional home loan and have an Adjusted Gross Income (AGI) at or below the low-income threshold (which varies by geography).
3. USDA Repair Loans & Grants
USDA repair loans and grants are sometimes known as the Section 504 Home Repair Program [1]. These loans and grants help homeowners repair, improve, or modernize their homes. They are also available to elderly low-income homeowners to resolve health and safety hazards. Repair loans offer low interest rates and can be repaid over 20 years. Grants are available to homeowners aged 62 and older and do not need to be repaid.
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USDA Loan Eligibility and Requirements
Eligibility for a USDA loan requires applicants to meet a set of criteria that ensure the program serves the intended purpose of aiding those in rural areas to find a way to home ownership. Knowing more about what is required is the first step toward successfully applying for and obtaining a USDA loan.
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Income Limits
If you are a high-income earner, a USDA might not make sense for you. One of the first variables considered when applying for a USDA loan is income. Because USDA loans are designed for low- to moderate-income individuals and families, there are income limits to ensure that the program is not abused by those who do not fit the intended socioeconomic demographic.
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Generally, your household income cannot exceed 115% of the median income in your area. The USDA provides an online tool to help applicants determine if their income falls within the acceptable range for their desired location.
Credit Score
While the USDA does not set a strict minimum credit score, lenders typically look for a score of 640 or higher. This benchmark indicates a moderately strong credit history and increases the likelihood of computerized processing through the USDA's automated underwriting system.
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Eligible Properties
Conditions for USDA loan eligibility will typically require the property to be in a USDA-designated rural area, which can include many suburbs and exurbs. Your home must be used as your primary residence and meet specific safety and sanitary standards as assessed by a USDA-approved appraiser. There are also some size and cost limitations to the program, and the USDA website offers a map to help potential applicants find properties that may qualify.
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Pros and Cons of USDA Loans
USDA loans have their advantages and disadvantages. Before you apply for your USDA loan, do your due diligence, and understand all the moving pieces of a USDA loan.
Advantages of USDA Loans
No Down Payment: In many cases, you can finance up to 100 percent of a home’s purchase price, which eliminates the need for a down payment. Not having to save for a down payment makes homeownership much more accessible to those who find it hard to build an emergency fund or slush fund, let alone accumulate significant savings for a 20 percent down payment.
Lower Mortgage Insurance: USDA loans require a guaranteed fee, which functions similarly to mortgage insurance but at a lower cost than private mortgage insurance (PMI), which is usually required for other loans with lower down payment requirements.
Flexible Credit Guidelines: A 640 credit score is generally required for a USDA loan. However, there are exceptions. USDA loans offer flexibility for applicants with lower credit scores via manual underwriting, making it possible for more individuals to qualify in the right circumstances [2].
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Disadvantages of USDA Loans
Geographic Restrictions: USDA loans are only allowed for homes in designated rural areas, which can be a limitation if you want to live a little closer to the nearest city. Living in rural America can limit how much money you can make and your day-to-day activities.
Longer Processing Times: Due to the additional eligibility requirements and the need for USDA approval, the loan processing time can be longer than conventional loans. If you are trying to purchase a home quickly, this slow processing time can be a significant drawback.
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How to Apply for a USDA Loan
Just like the conventional loan application process, the USDA application process has many nuanced steps. Understanding and navigating the USDA loan application process can take some lead time. You should be prepared for how long it takes while you are applying for a USDA loan. Here is a high-level roadmap to the application process:
Check Eligibility: Before anything else, verify your eligibility based on income, credit, and property location. The USDA website offers tools and information to help you determine if you and the property you are interested in qualify for a USDA loan.
Find a Lender: Not all lenders offer USDA loan products, so you will need to find one that participates in the USDA loan program.
Pre-Approval: This involves providing financial information to the lender, who will then assess your creditworthiness and eligibility for a USDA loan.
Find an Eligible Home: With pre-approval in hand, you can start house hunting within USDA-eligible areas. Remember, the property must be in a designated rural area and meet USDA guidelines.
Loan Application: This step requires detailed financial, employment, and personal information, along with property details.
Underwriting and Appraisal: The lender will process your application, which includes underwriting to assess risk and an appraisal to determine the property's value and ensure it meets USDA standards.
Final Approval and Closing: The last step is the closing process, where you will sign all the necessary paperwork, finalize the loan, and take ownership of your new home.
USDA Loan Fees
USDA loans come with specific fees unique to this type of mortgage, and understanding what is involved with these fees can take a lot of the mystery out of the home-buying process and help you be well-prepared when starting the process.
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The USDA requires an upfront fee like a mortgage insurance premium (typically about 1% of the loan amount), which can be added to the loan. There is also an annual guarantee fee, which is capped at 0.5% of the average annual scheduled unpaid principal loan balance [3]. Finally, there are the standard closing costs that can often include things like lender fees, title fees, and recording fees.
Smart Summary
Buying a house is part of the American dream. Being prepared for that purchase is one of the smartest money moves. Whether you are struggling to save for a down payment or want to live in a rural area and meet the income requirements, a USDA loan could make perfect financial sense for your financial situation. No matter what type of mortgage you are considering, establishing an emergency fund, slush fund, and saving for hidden home costs will make you even more prepared to purchase your dream home.
(1) USDA.gov. 504 Single Family Repaid Loans and Grants. Last Accessed January 30, 2024
(2) USDAloans.com. USDA Loan Income and Credit Eligibility. Last Accessed January 30, 2024
(3) USDA.gov. Upfront Guarantee Fee & Annual Fee. Last Accessed January 30, 2024
