When it comes to shopping for a mortgage, there’s no shortage of options to choose from. If your search includes rural and lower-population areas, you might consider a USDA loan.
Let’s look at what a USDA loan is, how it works and how it compares to other mortgage options.
What Is A USDA Loan?
A USDA loan (also known as a Rural Development loan) is a mortgage that is backed or directly guaranteed by the U.S. Department of Agriculture (USDA). Because they don’t require a down payment, USDA loans provide an affordable borrowing option for home buyers looking to purchase a property in a rural area.
How Do USDA Loans Work?
In many ways, USDA loans function similarly to conventional loans. For example, with both types of loans, borrowers will pay the same closing costs and adhere to the same repayment schedules.
There are, however, some unique advantages and disadvantages to USDA loans.
No Down Payment Required
With the USDA loan, there’s no down payment required. This is a striking difference from most conventional loans, and it makes this loan program a particularly attractive option for low- to moderate-income home buyers.
Most loans that allow borrowers to make low (or no) down payments require a form of mortgage insurance. This is meant to protect the lenders and/or investors backing the loan.
The USDA version of this insurance is called a guarantee fee. USDA loans have upfront guarantee fees of 1% of the loan amount, after which the annual guarantee fee is 0.35% of the average unpaid principal balance each fiscal year.
Relative to other mortgage options, USDA loans offer competitive interest rates. That said, in order to get the best rates for any home loan, it pays to have a strong credit score and minimal recurring debts.
USDA Eligibility And Requirements
To qualify for a USDA loan, applicants must be U.S. citizens or legal permanent residents.
Beyond that, eligibility for a USDA loan depends on several factors, including geographic location, as well as your income, debt and credit score.
Here’s what you need to know.
Eligible Areas And Properties
USDA loans were designed to help develop affordable housing in rural areas. USDA loans are not available in or around large, populated areas.
Fortunately, most of the country qualifies to get a mortgage under this loan program. You can check area eligibility by putting an address into the USDA eligibility map. If you’re looking to buy in an area that’s not marked by the color orange, you may be eligible for a USDA loan.
Eligibility for a USDA loan depends not only on location, but on the type of property as well. For a property to be USDA-eligible, it can’t include a working farm. Additionally, USDA loans can only be used to purchase a single-unit primary residence.
To qualify for a USDA loan, you and all the adults in your household can’t make more than 115% of the median income in your area.
Household income is a meaningful distinction because it includes the income of those adults living with you without regard to whether they’re on the loan.
Fortunately, you can exclude the cost of childcare under many circumstances. It’s also important to note that if any adults in the home are full-time students, only a certain portion of their income is counted for qualification purposes.
You can use this income calculator from the USDA to help you get an idea of whether you qualify.
Credit And DTI Requirements
Credit and debt-related requirements for a USDA loan will vary by lender.
That said, to qualify for a USDA loan, you’ll want a FICO® credit score of 640 or above.
For the best chance of qualifying, your debt-to-income ratio (DTI) – a comparison of your monthly debt payments against your overall monthly income – shouldn’t exceed 50%. To increase the likelihood of approval, keep your DTI at 45% or less.
Should You Get A USDA Loan?
There’s no denying the attractiveness of a loan with zero down payment, but like any mortgage, USDA loans come with disadvantages, too. Even if you satisfy all of the eligibility requirements (and don’t mind paying the guarantee fee), you may have difficulty finding a lender that offers USDA loans.
No matter what you decide, it always pays to research multiple options to find the right match for your borrowing needs. For example, you might consider a 30-year fixed-rate mortgage, which can help borrowers minimize their monthly payment because of its long loan term. Eligible veterans might also consider a VA loan, which doesn’t require a minimum down payment.
Unsure of where to go from here? Speak with a Home Loan Expert.