What is a USDA Loan?

29 Sep 2020

The United States Department of Agriculture offers three USDA home loan programs – loan guarantees, direct loan, and home improvement loans and grants - to help low-and-moderate-income applicants buy or build a new home and help existing homeowners fix up homes, in rural and suburban areas. USDA loan is a zero down-payment mortgage option. It is designed by private lending institutions and guaranteed by the US Department of Agriculture.

The motive behind these programs is to help the low or moderate income people buy or repair a house in certain parts of the country. To get a USDA loan, borrowers must be US citizens or eligible non-citizens who will live in the home they are borrowing.

Kinds of USDA loans

There are three kinds of USDA loans.

USDA Direct Loans:

Low or very low income borrowers can get funds directly from USDA under this program. Funds can be used to buy, build, renovate, or relocate the property in eligible region of the country. Income criteria may vary from region to region. Potential buyers need to contact their Rural Development office directly. Interest rates on this type of loans could be as low as 1% and comes for a longer repayment tenure, up to 38 years. 

USDA Guaranteed Loans:

Under this program, borrowers get a mortgage from an approved lender, but – similar to FHA and VA-backed loan programs – USDA approves 90% loan guarantee. This makes it easier to get a loan even with a down payment. This mortgage has household income limits; you won’t qualify for this home loan if your income is too high.

Home Improvement Loans and Grants:

Low or very-low-income homeowners can get up to $20,000 loans, and up to $7,500 grants to repair or upgrade their homes.

How USDA Loans Work

The USDA loan is a zero-down-payment mortgage for low-to-moderate-income applicants to boost homeownership in rural and suburban areas. All USDA loans are designed to make it easier for potential homebuyers, who otherwise don’t qualify for conventional financing due to lack of income and down payment, to obtain a loan. USDA loans are similar to other government-backed loans. Prospective homebuyers will get loan for a property they will be using as a primary residence.  

Eligibility for USDA loans

You need to meet the following criteria to qualify for USDA-backed mortgage loan

  • You should be a US citizen or eligible non-citizen
  • Should have a low income, depending on income criteria for your region
  • Should make the home you are buying your primary residence
  • Home that you want to buy or repair should be in an eligible area of the country
  • Have to prove your eligibility to meet credit obligations
  • Should meet program specific criteria, for example, to qualify for USDA guaranteed loan, you can’t make more than 115% of maiden income in your area
  • Should have a decent credit score – 640 or higher

How to apply for a USDA loan?

The application process for a USDA loan varies based on what kind of loan you want- direct loans, guaranteed loans, or loans or grants for the repair of an existing house.

  • To apply for a guaranteed loan, you need to apply with a USDA-approved lender
  • To apply for direct loans, you need to submit an application to your local USDA state office
  • To apply for a loan or grant for fixing up single family housing, submit an application with a USDA home assistant in your area

Interest rate on USDA loans

Generally, the interest rate applicable on a direct loan is 3.50% and could be as low as 1%. For a loan for home repair / renovation or modernization, the interest rate is 1%.

What is the maximum loan amount you can borrow under USDA loan programs?

For direct USDA loans, the maximum loan you can borrow depends on your repayment capacity based on your income and other debt. Cost of the home you buy or build with a USDA loan should not exceed the loan limits defined for the area.

For guaranteed loans by the USDA, the maximum loan you can get depends on how much a lender is willing to offer, but it can’t go beyond the purchase price including other associated costs as defined by the USDA.

And if you want get a home repair loan, you can borrow up to $20,000 - and eligible elder can get additional grants up to $7,500. So, USDA can finance up to $ 27,500 for home improvement / repair/ modernization.

Benefits of USDA loans

USDA loans entail a host of benefits described below:

Most of the areas are eligible

While you are eligible to purchase / build or renovate a home with a USDA loan in qualified rural areas, an estimated 97% of the US comes under rural area. According to guidelines, a rural area is any area that has a population of less than 35,000 people.

Many property types are eligible

You can get USDA loans for any type of residence you might be willing to have, from construction and purchase of a new home and existing single-family home to modular homes and even townhouse.

Available even after a foreclosure or bankruptcy

You can get a USDA loan after bankruptcy or foreclosure. According to USDA guidelines, after a three-year waiting period, you can be eligible for USDA home loans after Chapter 7 bankruptcy.

Lowest mortgage insurance fees

When you seek a USDA mortgage, you will need to pay an upfront fee of 1% of the loan amount and then 0.35% of the loan balance as annual mortgage insurance fee.

Flexible credit guidelines

Generally conventional loans need a credit score of 720. While USDA loans don’t require a credit score, the lender who makes the USDA loan may require a credit score around 640. USDA loans are good options for someone with a lower credit score.

USDA loans have no pre-payment penalty

For a conventional loan, lenders may require you to pay the penalty if you pay off your loan before a defined tenure. With USDA loans, there is no pre-payment penalty, which means you can clear your loan whenever you like, with a windfall if you sell your house or win the lottery.

 What makes USDA loans different from conventional loans?

USDA loans are different from conventional loans in several ways described below:

  • Most conventional loans need a down payment of 5%, although borrowers with an excellent credit score may have to make only 3% down payment in some cases. With USDA loans, you don’t need to make a down payment.
  • Interest rate applicable on a USDA loan is much lower than that on conventional loan
  • While a borrower with a higher income easily qualifies for a conventional home loan, USDA loans are intended for a borrower with lower income. USDA loans have income limits, and if your income exceeds that limit, you can’t qualify for USDA loans.
  • While a conventional loan is intended for properties anywhere, there are restrictions on properties for USDA loans.
  • While conventional lenders charge fees for a loan, it may be negotiable. USDA loans charge an upfront fee for loan and mortgage insurance fee.