USDA Home Loans: What They Are & How They Work

USDA home loans are issued through the Rural Development Guaranteed Housing Loan program of the U.S. Department of Agriculture. This mortgage assistance program can be a powerful pathway for potential homebuyers.

It helps make purchasing a home more affordable for low- to moderate-income individuals in eligible rural areas. A USDA loan can be used to buy or refinance an existing home at a low rate.

In 1991, the U.S. Department of Agriculture introduced the Single-Family Housing Guaranteed Loan Program to boost homeownership in rural America. As a result, low- and moderate-income homebuyers who may not qualify for a traditional mortgage can apply for a government-backed loan to purchase, construct or renovate homes in eligible rural areas.

During the 2019 fiscal year, lenders issued nearly 100,000 loans under this program. USDA mortgages do not require a down payment, and they usually come with low interest rates.

Payback periods for USDA loans may stretch to 33 years or even up to 38 years for the lowest-income applicants. Under its terms, the USDA guarantees 90% of the loan if the borrower defaults.

First-time and repeat homebuyers can use 100% of a USDA home loan to finance the purchase of a home. Unlike other home loan types, a USDA home loan doesn’t require a down payment. Borrowers will need to take out a fixed-rate loan since this mortgage assistance program does not allow adjustable-rate mortgages.

There are three main mortgage programs under USDA:

• Single-Family Housing Direct Home Loans: These loans help low- and very-low-income applicants get mortgages. The property must be located in an eligible rural area, and income requirements vary based on where the borrower lives. The repayment period could be up to 33 years, possibly extending to 38 years for qualified borrowers.
• Section 502 Guaranteed Rural Housing Loan: This program helps low- and moderate-income applicants receive 100% financing on their homes with no down payment. Repayment for these loans is offered at 30-year fixed-rate terms only. As with direct home loans, applicants for the guaranteed loan must meet income requirements, and the property must be located in an eligible rural area.
• Section 504 Home Repair Program: This loan helps qualified borrowers finance home repairs, improvements and modernization. The borrower must be the homeowner, occupy the house and have a household income lower than 50% of the local median income. Loan amounts can’t be more than $20,000 in a 20-year repayment period.

There are several eligibility requirements for each Section 502 loan. For direct loans, applicant requirements include:

• Must be without decent, safe and sanitary housing.
• Must not be able to get a loan from other lenders with terms they can reasonably meet.
• Must occupy the property as their primary residence.
• Must be legally able to take on a loan
• Must meet income eligibility, which is based on where they live
• Must meet citizenship or eligible noncitizen requirements
• Must not be suspended or barred from taking part in federal programs

Property requirements include:

• Must be in a rural area with a population of less than 35,000
• Must be 2,000 square feet or less
• The property must have a market value less than the applicable area loan limit
• The property cannot include an in-ground swimming pool
• The property cannot be designed for income-producing activities

For guaranteed loans, the applicant must meet the income requirements, agree to use the home as their primary residence and be a U.S. citizen, a U.S. noncitizen national or a qualified alien. The property must be located in an eligible rural area.

If you don’t qualify for a USDA loan, a Federal Housing Authority (FHA) loan could be a good option.

USDA home loans require qualified borrowers to take a fixed-rate loan on either a 15-year or 30-year repayment period. The lender will determine the interest rate based on factors including credit score, employment history and financial situation.

If you plan to take out a USDA loan, it’s important to remember that you will have some closing costs, even if you aren’t required to make a down payment. Your closing costs include fees and charges that come with finalizing a mortgage. The amount you’ll need to pay depends on location, but it’s usually somewhere between 1% to 3% of the loan amount.

For more information, check out the U.S. Department of Agriculture's single-family housing programs.

For many homebuyers, USDA loans could be an alternative to conventional mortgages or other government programs such as FHA or VA loans. These advantages include:

• Zero down payment: Unlike other mortgage loans, borrowers won’t need to provide a down payment for USDA loans. Coming up with a hefty down payment can be a barrier for many people looking to purchase a home.
• Low credit score: USDA loan programs do not mandate a minimum credit score to qualify for a mortgage. However, you must demonstrate the ability and willingness to repay the loan.
• Flawed credit history can still be OK: A low credit score often reflects poor credit history, which can deter lenders from offering conventional mortgages. However, the USDA uses its Guaranteed Underwriting System to see if a borrower qualifies for a loan. There is more flexibility in reviewing qualifications to help borrowers as much as possible.
• Low origination fee: With USDA loans, borrowers pay a guarantee fee of 2% of the total loan amount. However, this fee doesn’t have to be paid up front; it can be rolled into the mortgage loan amount.
• Rates: Rates on USDA loans are typically lower than those on conventional or FHA loans. This is good news for borrowers with lower credit scores because they can receive those same low rates as borrowers with excellent credit scores.
• Streamlined refinancing process: The USDA’s streamlined assist refinance loan program speeds up the process to approximately three weeks for homeowners looking to refinance their mortgage. You won’t need credit reports, a home appraisal or a property inspection.

There are certain drawbacks to USDA loans that borrowers may not encounter with conventional mortgages or mortgages through other government programs such as FHA and VA. These include:

• Geographical requirements: Homes must be located in an eligible rural area with a population of 35,000 or less. Also, the home cannot be designed for income-producing activities, ruling out certain rural properties.
• Second property/vacation homes not allowed: The property must be used as the borrower’s primary residence.
• Income limits: Borrowers must meet specific income requirements based on where they live. If you exceed the income limits, you will not qualify for a USDA loan.
• USDA up-front fee: Borrowers must pay an up-front fee for a USDA guaranteed loan or have that fee rolled into the mortgage loan amount. Depending on that loan amount, this could be several thousand dollars.
• Streamlined refinancing limitations: To qualify for a refinance, you must have a record of 12 consecutive, on-time mortgage payments, and the home must be your primary residence. This program only applies to mortgages with 30-year terms and is not available in all states.

In addition to USDA home loans, there are other mortgage programs available, including conventional home loans, FHA loans and VA home loans. USDA mortgage interest rates are the lowest of all these options.

When it comes to requirements (such as down payments or credit scores), a USDA home loan is matched only by a VA loan. However, this option is only available to veterans, service members and qualifying surviving spouses.

FHA and conventional loans tend to have higher interest rates. They can also be hard to qualify for. Depending on your unique situation, another type of mortgage may better suit your needs.

Knowing the answers to some of the most commonly asked questions about USDA home loans is an excellent next step and can help you decide whether you may benefit from this type of loan.