Buying a house is a lifelong dream for most Americans. But it’s not always possible to buy a property with your own money because the housing market is at an all-time high right now. It means you’re more likely in need of a loan to support the dream.
There are various loans like the FHA loan, the VA loan, and the conventional loans. The FHA loans are targeted toward individuals with lower credit scores. The VA loans are for veterans, service members, and their surviving spouses. And the conventional loan programs are designed for people with a sustainable income with good credit scores.
But what if you don’t qualify for any of them? What if you live in a rural area where getting finance for your housing project is next to impossible?
Well, America is a land of hopes and we have hope for you. It’s the USDA loans! The United States Department of Agriculture is mostly associated with, well, agriculture-related stuff. Plant inspection, food safety, etc. are in its ballpark.
But did you know that USDA has been giving loans to low-income individuals living in rural areas to buy houses? It’s been doing it since 1991! USDA is heavily involved in rural development along with the agricultural stuff we can think of.
In this post, we’re going to learn everything there is about USDA loans. So, if you thought your dream of owning a home will remain unattained, you were wrong!
What is a USDA Loan?
If you’re familiar with how other loans like the FHA, conventional, or VA works, understanding USDA loans would become easier for you. In 1991, USDA brought the Single Family Housing Guaranteed Loan Program to light. It was done to increase the rate of house ownership in the rural areas of the country.
One of the big reasons USDA had to jump in is because, traditionally, rural areas are associated with low to moderate-income individuals who don’t qualify for regular loan programs. The requirements are often too high and the residents of such areas don’t see it feasible to pay the higher interest rates.
USDA loans changed it all. The qualifying applicants can loan and buy their preferred property for a $0 down payment. It’s very similar to how the VA loan program works for veterans.
According to a survey done in 2017, USDA has helped over 127,000 families to purchase and/or upgrade their homes. It’s a huge number. Also, it’s an interesting takeaway how many low-income families live in the rural areas of America.
How Does USDA Loan Work?
Similar to how FHA or VA loans work, USDA loans are guaranteed by the USDA and provided by local lenders in your area. In case you default on the mortgage, in the long run, USDA covers up to 90% of the mortgage as well!
Although these loans allow you to put little to no down payment, it won’t be a very good idea. Because when you don’t meet the minimum threshold for the down payment, you’ll need to take on mortgage insurance. It’ll add extra payments every month for as long as the loan stretches.
Talking about loan terms, they can be quite extensive with USDA loans. Typically, a USDA loan can stretch up to 33 years! Records show that there are 38 years of loan terms as well for even lower-income individuals.
That’s a lot of flexibility that you don’t get with any other loan programs.
USDA even issues direct loans which are very unlikely for any loan programs. It’s one of the reasons USDA loans are special! If you take out a direct loan, it means you’re living on the very low band of the income spectrum of the country. To ease your burdens, the organization offers as low as 1% interest rates!
On top of your initial loan, you may also qualify for home improvement loans and grants. Yes, you read that right! After evaluating your condition, USDA may reward grants to you for improving your living conditions. As of now, the package can be up to $27,500!
USDA targets the families with the greater needs when it goes through the applications. Certain conditions will have an edge over the other one.
Such conditions can include families who don’t have decent, safe, and sanitary housing. Families or individuals who don’t have the means to get approved for a home loan for traditional (FHA, conventional, VA) loans. And families that have an adjusted income that goes below the low-income limit for the particular area.
Types of USDA Loans
The loans guaranteed by the United States Department of Agriculture have two major branches. The mother branch is known as the USDA Section 502 loans. And the two branches are known as Single Family Housing Guaranteed Loans and Single Family Housing Direct home loans.
Single Family Housing Guaranteed Loans
These loans are 100% guaranteed by the USDA. It means you get 100% financing for purchasing the property you’ve been dreaming about. As we’ve already said, you may need to pay for additional insurance every month if you put no down payment at all.
You’ll be paying fixed interest rates for the life of the loan, usually hovering around 30 years. You need to meet the income requirements and the property you choose must be in the eligible rural areas.
Single Family Housing Direct Home Loans
The term ‘direct’ in the name means that this loan comes directly from the Department of Agriculture. It’s targeted more toward low to very low-income spectrums. The loan terms can go up to 38 years if you manage to qualify yourself!
The other requirements are similar to the guaranteed loans. Meaning you need to match the income threshold and find the right property in the right neighborhood. The USDA usually approves direct loans for properties under 2,000 square feet.
But just because a property area is 2,000 square feet or less doesn’t mean you’ll get the loan. The vicinity of the property will play an important role as well. It must remain under the loan limit for the area. The range can be anywhere between $100,000 and $500,000!
What are the Qualifying Factors for USDA Loans?
These loans sound amazing, right? So, how do you qualify for one? Although the loan program is designed for low-income individuals and to make their lives easier, there are certain requirements that the applicants must meet to get approved.
Let’s take a brief look at what those are.
Citizenship
To qualify for a USDA loan, you must be an American national or a qualified alien. It means you either need to be an American citizen or a non-citizen national. If you don’t meet either criterion, there is a third option for you. And it’s being a qualified alien.
A qualified alien is someone who has been granted permanent residency under the Immigration and Nationality Act (INA). If you’ve been granted asylum under section 208 of the INA, you can also be identified as a QA. Lastly, if you’re a refugee admitted to the US, you can be called an alien according to INA section 207.
If you don’t fall into any of the criteria we’ve mentioned so far, then you cannot apply for the USDA loans. As unfortunate as it may sound, it’s true. In that case, your first priority should be to get your documentation right.
After you successfully make one of the categories we’ve discussed, you can apply for the loan and get yourself a new home!
With the residency factor knocked out of the park, let’s move on to the other qualifying criteria.
Credit Score
The credit score factor is like the nightmare that keeps coming back. In America, no matter what you want to do, you may need your credit score to speak for you. The same is true for USDA loans.
For USDA loans to work, you’ll need at least a 640 FICO score. However, there are many local lenders who would be willing to give you a loan with lower scores. But you may need to pay for mortgage insurance or a higher interest rate.
If you’re not willing to pay extra for the interest, get your credit score together first. It shouldn’t be very hard for you given that you don’t have too much money flowing in and out of your account.
Income
To get approved for the loan, you’ll need to meet a minimum income threshold set by the Department of Agriculture. The whole idea behind designing a loan program for the lower-income spectrum is to give them hope.
So, your gross income cannot go over 115% of the median for the local area. Don’t confuse it with the national median. USDA loans are targeted to certain geographic locations so the bigger picture is quite irrelevant. You can find the formula online by selecting your area on any loan calculator.
Also, you’ll need to prove to the lender that you have a stable income source. The lender needs reassurance that you’ll be able to pay for your mortgage for at least 12 months from the date of the loan getting approved. The evaluation will include your income, your current assets, and your savings.
Debt to Income Ratio
It’s pretty much the same as our previous point. But this is in the form of a ratio. The debt to income ratio or DTI is relevant for every type of loan program there is. For USDA loans, the threshold is 50%.
It means that the debt you’ll pay every month cannot go over 50% of your income. Again, the ratio can vary from area to area and lender to lender. You’re better off walking into your local USDA-approved lender and talk with a loan officer about your options.
How Are USDA Loans Different from Other Loans?
So far, USDA loans sound amazing, right? You may have found various similarities between these loans and other traditional loans. But what are the differences? What factors set this one apart from the rest of the bunch?
Let’s find out!
Down Payment
We’ve stated multiple times in previous sections that USDA loans don’t require any down payment. It’s very similar to how VA loans work.
Traditional loans, meaning FHA and conventional loans have a varying degree of down payment requirements. It can start at as low as 3.5% and go all the way up to 20%.
But with USDA loans, it’s flat 0%. It’s a huge advantage because the ultimate goal of such loans is to provide the support low-income individuals need. You can’t put a price on the happiness they’re going to get after they realize their housing dream may come true!
So, if you’re not a veteran and don’t qualify for regular loan programs, USDA is a valid option for you.
Guarantee Fee
No matter what type of loan you seek for, the lender will need some sort of guarantee that you’re going to pay them back. For conventional lenders, it’s the down payment. For FHA loans that require only a 3.5% down payment, it’s the private mortgage insurance. For VA loans, it’s the funding fee that you pay directly to VA.
For USDA, it’s still insurance, but the interest rate is much less than any other loan program in circulation. The interest rate of USDA loans is capped at a flat 1%. It means you’ll still need to pay a premium for not paying any down payment, but the amount will be much less.
Appraisals
It’s another universal requirement for all loan programs. Starting from FHA to conventional loan to VA and USDA loan, you’ll need to get the property appraised before you can get into a concrete contract with the seller.
However, the purpose of getting your selected property appraised is different for USDA loans and other loans. In other loans, you do it to ensure that the market value of the house is relevant to the loan amount you’re getting. If the appraisal value falls short, it’s considered a loss for the lenders.
But with USDA loans, you get the property appraised to ensure that it meets the USDA standards. The house must be in livable conditions. The roof, the water supply, the heating system, etc. should comply with the building codes of the area. The windows should all be intact.
There is a difference between an appraiser and a home inspector. An inspector can always go deeper in finding underlying issues than an appraiser. It’s not even the appraiser’s job to find critical issues. They just look at the condition of the property with naked eyes and put a value on it.
Also, the purpose of making sure that the loan amount is appropriate according to the condition of the property is another reason to get an appraisal, similar to other loans.
Steps to Getting Qualified for the Loan
Now that you know pretty much everything there is about the USDA loans, let’s look at the process of getting one.
Preapproval
This stage is very similar to VA loans. You need preapproval from your lender for the loan. A loan officer will review all of your documents to ensure that your financial condition qualifies for it. preapproval is the phase when you’ll know how much you can get from the lender. There is some room for negotiations. But don’t get your hopes too high.
House Hunting
Once you know how much you will get as the loan, it’s time to find properties that fit into your budget. You already know that to get final approval from the USDA, the property must meet some criteria. Keep them in mind while you’re going through the listings. Taking help from a real estate agent would be a very good investment in this case.
Signing Off the Mortgage
After you like a property, it’s time to sign the mortgage off. The appraisal of the property takes place in this stage. The loan officer from the lending company will go through your documents one last time and validate the numbers in accordance with the property you chose.
As long as your desired property meets all the USDA guidelines and it costs between your margins, there shouldn’t be any complications.
However, if the property’s price falls short in the appraisal, you may need to negotiate with the seller for a reduced price or let the property go.
Final USDA Approval
The moment of truth. There’s nothing to be worried about. As long as you follow all the guidelines and complete the previous steps successfully, you’ll get the approval. The submission will be done by your lending company so you won’t need to visit the USDA or face any questions at all.
Signing the Deal
After you get USDA’s final approval, there’s nothing between you and the property you chose. All there is left to do is signing off the deal with the seller and start packing.
Advantages and Disadvantages of the USDA Loans
We often say one thing in our posts. And it’s that nothing in the world is perfect. It’s true for USDA-approved loans as well. You’ll benefit from some features while some others will cause you stress. It’s the true nature of the world.
We’ve discussed various advantages and restrictions of the loan program throughout our post. Now, we’ll concentrate on the merits and demerits of the loan one last time.
Advantages
- No Down Payment: This is the biggest advantage of all. If you’re already a low-income individual, it’s hard to live the life you want and the life you want to give your family. It’s understandable if it’s nearly impossible for you to save up for a down payment on a loan. USDA has got you covered in this regard with the zero down payment policy.
- Relatively Low Credit Score: The credit score requirement for USDA loans might not be as low as the FHA, but it’s still considerably low. With a score of 680, you can easily get approved for the loan.
- Low Funding Fee: The funding fee is often adjusted to the entire loan amount and you get to pay it throughout the term of the loan. The interest rate is capped at 1% which is a great advantage in the long run.
- Easy Refinancing: Refinancing your existing mortgage is quite easy with USDA loans. There are many assistance programs that are readily available to get you out of a jam.
- Flexibility: Our favorite benefit of the USDA loans would be the flexibility. Lenders are often willing to work with very low-income individuals as well as with those with a flawed credit history. This kind of flexibility is unheard of with other loan programs.
Disadvantages
- No Second Home: USDA loans are strictly for people who are in need of a primary residence. If you planned on getting a loan for a vacation home, USDA is not the right approach for you.
- Property Requirements: The property must meet certain guidelines from the USDA to be qualified for a loan. It can often be hard to find the right property in your local area. Moreover, farmhouses are out of the question because the properties cannot be used for money-making. Make sure you’re hiring a real estate agent who knows about the loan USDA guidelines.
- Geographical Requirements: USDA loans are strictly for rural areas. Under the loan program, a rural area is considered where the maximum population is 35,000.
- There is a Premium: You must pay the up-front fee for the zero down payment facility you’re getting. It means you’ll need to pay the USDA fee. You can either pay it upfront or roll it over with your loan.
Wrapping Up
Having a house is a lifelong dream for many people. But it often doesn’t come true due to the lack of financing. People with good credit scores or good DTI have options to get approved for various loans like the FHA, VA, or conventional loan.
For those who can’t qualify for any of these, USDA might be a valid option. You should go into your local lending company’s office and talk with a loan officer to see whether you qualify for the loan or not!
