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What is a USDA Home Loan?
A USDA Loan is a mortgage that is insured by the United States Department of Agriculture. This loan was created by the USDA as part of the ‘Rural Development Guaranteed Housing Loan’ program. The main purpose of USDA loans is to provide opportunities to individuals in rural areas to become homeowners. Rural areas account for 97% of the nation’s landmass making this loan available to approximately 60 million people! USDA loans are also eligible for any property type from single-family, multi-family, condominiums, townhouses, and new construction.
What are the USDA Loan Eligibility Requirements?
The USDA loan program has several requirements that need to be met in order to qualify for the mortgage. The USDA loan requirements are as follows:
|Status||US Citizen or Lawful Permanent Resident|
|Location||Population < 20,000|
|Type of Residence||Primary Residence|
|Household Income||Household Income < 115% Median Income|
|Debt Requirement||Debt-to-Income (DTI) Ratio < 41%|
|Minimum Credit Score||No Credit Score Requirement|
An in-depth description, eligibility calculator, and USDA loan map can be found on the USDA Loan Eligibility page.
Types of USDA Loan Programs
Three different types of USDA Loan Programs are available:
- Loan Guarantees - USDA guaranteed loans are provided by USDA approved lenders which can be banks and other institutions that provide mortgages. This type of loan is similar to the FHA Loan and VA Loan. As these loans are insured by USDA, you can get competitive mortgage rates and put little to no down payment.
- Direct Loans - This program is known as the Section 502 Direct Loan Program. These loans are issued directly by the USDA and not lenders, however, it is restricted to low and very low-income households. In this program, the USDA looks at adjusted income where expenses such as childcare and medical expenses are deducted from the household income. The income to qualify is 50% less than the median income of the area, income limits can be checked here. For example, if the median income in your area is $50,000, your annual adjusted income to be considered low-income cannot be greater than $25,000 ($50,000*50%). There are various subsidies available which can reduce mortgage rates to as low as 1%.
- Home Improvement Loans - This program is known as the 504 Home Repair Program, it is restricted to low-income families for home improvements or the elderly for the removal of health and safety hazards. The adjusted income is used where childcare and medical expenses are deducted from household income. To qualify, adjusted household income must be less than 50% of the median income in the area. The maximum loan amount is $20,000 and the maximum loan grant is $7,500.
How do I apply for a USDA Loan?
The process of obtaining a USDA home loan is not that different from obtaining a conventional loan, here are the following steps:
- Find a USDA approved lender and pre-qualify for a loan - Finding a USDA approved lender is the first step, it is advised to find a lender that specializes in USDA loans as the process becomes easier as they have the necessary expertise. Once the lender is chosen, the next step is to get pre-qualify. The lender will require only basic information at this stage such as borrowing amount, income, and debt information. This step helps determine how much you can afford and what monthly payments can be made for the life of the loan. The pre-qualification process can be done online but varies from lender to lender.
- Pre-Approval Process - This stage is crucial and requires a lot more information as compared to pre-qualification, in this stage the lender will require all your information such as tax returns, debt, income & bank statements, social security, and government ID. This will help calculate the debt-to-income (DTI) ratio which is an important factor in determining eligibility.
- Find a USDA Eligible Home - In this stage, you find a home that is eligible for USDA loans, i.e. it meets the necessary rural requirement such as less than 20,000 people in the given area.
- Home Sale Process - In this stage you and your agent negotiate with the seller of the home and make a final offer. In some cases, you can get all closing costs removed by negotiating with the seller. Once the purchase agreement is sold, the lender will order a USDA loan appraisal. This is to ensure that the home is in good condition for the home buyer and meets USDA standards. Closing costs can also be packaged into the USDA loan if the appraised value of the home is greater than the purchase price. The appraised value of a home is determined by a professional appraiser using criteria such as market conditions, price of similar homes, and quality of construction, etc. For example, if the home selling price is $150,000 and the appraised value is $155,000, then you can claim $5,000 for closing costs.
- Underwriting & Processing - the underwriter will review all the contracts and information to ensure everything is accurate. This process is longer than the conventional process as the underwriting is done by both the lender and the USDA. The lender underwrites the loan file, following which all the information is checked by the USDA. This process is streamlined if you have a credit score greater than 640, if your credit score is less than 640, then the USDA will undertake the manual process where more information may be required.
- Closing and Home Ownership - This is the last stage, once all the documents are approved, you take ownership of the home on the closing date.
USDA Loan Refinancing
- USDA Streamline Refinance - This streamline process is similar to other streamline refinances such as the VA loan which has the VA Interest Rate Reduction Refinance Loan (IRRRL). The homeowner must be current on their last 12 mortgage payments, which will allow for refinancing without an appraisal of the home. There are certain other requirements such as the loan must be a USDA loan, the refinance request must be at least 12 months after the start of the loan, must meet the income and DTI requirements of the USDA, and the refinanced loan cannot be larger than the original loan amount.
- USDA Streamline-Assist Refinance - This program has fewer requirements as it does not require credit checks, DTI ratio checks, and appraisals. The streamline-assist refinance has all the requirements of the streamline refinance with some additional requirements such as, the refinance must lower the monthly mortgage payment by at least $50, and low-income and very low-income earners who have a direct USDA loan require a new appraisal if they choose to refinance.
- Non-Streamline Refinance - The non-streamline refinance is identical to the streamline refinance program, but the borrowers need to get an appraisal of the home. This might be the right choice for you if you want to avoid the $50 requirement of the streamline-assist program or you are looking to get an appraisal of the home.
Conventional Loan vs. USDA Loan
There are several benefits of the USDA approved loan as compared toconventional loans. The USDA loans can be the best loan option if the home is being purchased in a rural area, as there are no minimum down payment and credit requirements! As USDA loans are backed by the government, they offer lower mortgage insurance premiums and competitive mortgage rates as compared to conventional loans. USDA Loans do have an upfront fee of 1% of the loan amount and annual variable mortgage insurance of 0.35% of the unpaid principal that remains for the life of the loan. The fees apply to both purchasing a home and refinancing a mortgage.
|Criteria||Conventional Loan||USDA Loan|
|Minimum Down Payment||3% - 20%||No Minimum requirement|
|Minimum Credit Score||620||No Minimum requirement|
|Mortgage Rates||PMI : 2.5% - 2.745%*||2.25%*|
|Mortgage Insurance Premium||0.4-2.25% annually||1% upfront + 0.35% annually|
*As of December 22nd, 2020
There are several benefits of the USDA approved loan as compared to conventional loans. The USDA loans can be the best loan option if the home is being purchased in a rural area, as there are no minimum down paymentand credit requirements! As USDA loans are backed by the government, they offer lower mortgage insurance premiums and competitive mortgage rates as compared to conventional loans. USDA Loans do have an upfront fee of 1% of the loan amount and annual variable mortgage insurance of 0.35% of the unpaid principal that remains for the life of the loan. The fees apply to both purchasing a home and refinancing a mortgage.
FHA Loans vs. USDA Loans
FHA Loans and USDA loans are provided by approved lenders that are backed by government agencies, the Federal Housing Administration for FHA loans, and the United States Department of Agriculture for USDA loans.
|Criteria||FHA Loan||USDA Loan|
|Minimum Credit Score||500||No Minimum Requirement|
|Minimum Down Payment||3.5% if credit score is greater than 580 |
10% if credit score is between 500 and 580
|No Minimum Requirement|
|Loan Terms||15 and 30 years||30-year fixed|
|Income Requirement||A steady source of Income||Household Income < 115% of Median Household Income|
|Debt-to-Income (DTI) Ratio||DTI < 43%||DTI < 41%|
|Mortgage Insurance||Upfront FHA MIP + Annual Variable MIP||Upfront Funding Fee + Annual Variable MI|
|Mortgage Insurance Premium|
Upfront: 1.75% of loan
Annual: 0.45% - 1.05%
Upfront: 1% of loan
|Down payment Gifts||100% of down payment can be a gift||Gift money can be used for closing costs|
|Down Payment Assistance Programs||Yes||No|
- Minimum Credit Requirements - FHA Loan has a minimum credit requirement of 500 if there is a down payment of at least 10% and USDA loans do not have a credit requirement.
- Minimum Down Payment Requirements - FHA loans can have a down payment as low as 3.5% of the home price if the credit score is greater than 580 and the minimum down payment increases to 10% if the credit score is at least 500. USDA Loans do not have minimum down payment requirements.
- Loan Terms - FHA loans are offered with 15 and 30-year loan terms, the mortgage can be fixed or an adjustable-rate mortgage which uses an index as a benchmark such as the Prime Rate which is linked to the FED Funds Rate. USDA Loan only has the 30-year option, and the mortgage can only be a fixed-rate.
- Income Requirements - FHA loans require a steady income for at least 2 years, whereas for USDA loans the annual household income cannot exceed 115% of the median income.
- Debt-to-Income (DTI) Ratio - FHA loan requires a debt to income ratio to be less than 43%, whereas, USDA loan is stricter and requires it to be less than 41%.
- Mortgage Insurance - All FHA loans require mortgage insurance in the form of FHA Mortgage Insurance Premium (MIP). The FHA MIP is divided into an upfront fee and annual variable MIP. The USDA loan also has an upfront fee and annual variable mortgage insurance (MI).
- Mortgage Insurance Premium - The FHA upfront fee is 1.75% of the loan amount, the variable fee is in the range of 0.45% - 1.05%. The variable FHA MIP is dependent on the loan amount, down payment, and term of the loan. The USDA upfront fee is 1% of the loan and the variable mortgage insurance is 0.35% of the remaining principal balance.
- Down Payment Gifts - Down payment for FHA loans can be funded 100% by gift money, as long as the gift money can be proven that it is a gift and does not have to be repaid. USDA loans do not have a minimum down payment requirement, hence gift money does not apply. However, gift money can be used for closing costs.
- Down Payment Assistance Programs - FHA loans have down payment assistance programs that vary by location. USDA loans do not have minimum down payment requirements, hence, they do not have down payment assistance programs.