USDA Home Loans: What They Are and How They Work
- USDA Loans
USDA loans are low-interest, no-down-payment mortgages specially designed to help finance homes in eligible rural areas. So, for low- and moderate-income households who currently live or are considering moving to a rural area and want to buy a home, the USDA loan may present a good opportunity.
USDA loans provide financing to moderate- to low-income households, so there are strict income requirements.
Applicants must make sure the property is located in an eligible rural area with a population of less than 35,000.
Home-buyers with low credit scores may be eligible, and borrowers don’t need to worry about making a down payment.
What Is a USDA Loan?
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 home-buyers who may otherwise not qualify for a traditional mortgage can apply for a government-backed loan to purchase, construct and renovate homes in eligible rural areas. During the 2019 fiscal year, lenders issued nearly 100,000 loans under this program.
USDA mortgage loans do not require a down payment, and they usually come with low interest rates. Payback periods for USDA loans may stretch to 33 years — and possibly even 38 years for very low-income applicants. Under the USDA mortgage terms, the USDA guarantees 90% of the USDA loan if the borrower defaults.
Fixed interest rates on USDA loans are based on current market rates, which, as of February 2021, are 2.62%, with an average percentage rate (APR) of 2.803%.
Today's Mortgage Rates
- Type of LoanRateAPR
- Conventional 5/1 ARM2.551%3.276%
- Conventional 15-Year Fixed2.15%2.242%
- Conventional 30-Year Fixed2.863%2.915%
- FHA 5/1 ARM3.925%3.848%
- FHA 15-Year Fixed2.788%3.867%
How Does a USDA Mortgage Work?
There are two main categories of USDA section 502 loans: single-family housing guaranteed loans and single-family housing direct home loans.
- Single-Family Housing Direct Home Loans: These loans provide payment assistance to help low- and very-low-income applicants repay their mortgage. 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, with the possibility of reaching 38 years for qualified borrowers.
- Section 502 Guaranteed Rural Housing Loan: This program helps low- and moderate-income applicants receive 100% financing on their home with no down payment. Repayment for these loans is offered at 30-year fixed-rate terms only. As with the direct home loans, applicants for the guaranteed loan must meet income requirements, and the property must be located in an eligible rural area.
Neither loan requires mortgage insurance. Instead, the lender pays an annual guarantee fee to the USDA and recoups that fee in the monthly mortgage loan payment.
How To Qualify for a USDA Loan
There are several eligibility requirements for each section 502 loan. For the direct loans, applicant requirements include:
- Must be without decent, safe and sanitary housing
- Must not be able to get a loan from other resources 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 approximately 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 qualified alien. Of course, 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.
Advantages of USDA Loans
- Zero Down Payment: Unlike with other mortgage loans, borrowers won’t need to provide a down payment for USDA loans. Often, coming up with a hefty down payment can be a barrier for many people looking to purchase a home.
- Low credit score: The USDA loan programs do not mandate a minimum credit score to qualify for a mortgage loan. However, you must be able to demonstrate an ability and willingness to pay back the loan.
- Flawed credit history can still be OK: A low credit score often reflects a poor credit history, which can deter mortgage lenders from offering conventional mortgages. However, the USDA uses its own Guaranteed Underwriting System to see if a borrower qualifies for a loan. There is much 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; instead, it can be rolled into the mortgage loan amount.
- Rates: Rates on USDA loans typically are lower than those on conventional or FHA loans. This is good news for borrowers with lower credit scores because they still can receive those same low rates as borrowers with great credit scores.
- Streamlined refinancing process: For homeowners looking to refinance their mortgage, the USDA’s streamlined assist refinance loan program speeds up the process in approximately three weeks. You won’t need credit reports, a home appraisal or a property inspection.
Disadvantages of USDA Loans
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, which could rule 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.
Expert Insights on USDA Loans
MoneyGeek spoke with industry leaders and academics to provide expert insight on USDA loans. All views expressed are the opinions and insights of the individual contributors.
- Why should borrowers consider a USDA mortgage loan?
- Who are the best candidates for USDA mortgage loans?
- How can a borrower best prepare to qualify for a USDA mortgage loan?
- Are there any drawbacks to getting a USDA mortgage loan?
Frequently Asked Questions About USDA Loans
It's possible. The lack of a down payment and the option to roll closing costs into the monthly loan payments (instead of paying those up front) may make it a good option for first-time home-buyers. Plus, home-buyers with scant or even damaged credit histories may still be eligible for USDA loans.
From zero-down payments to few or no up-front expenses, USDA loans tend to be cheaper than FHA and conventional mortgages. Borrowers can also get 100% financing, and mortgage insurance premiums and closing costs can be rolled into the loan.
USDA loans typically take 35 to 40 days to close.
That depends on your circumstances. Your household income must be less than the USDA threshold for the type of USDA loan you seek, the property must be in a USDA-defined rural area and you must meet the USDA's credit and debt-to-income ratio rules.
Borrowers can use USDA loans to finance a condo. The requirements for single-family homes are generally the same. But the USDA will refer to guidelines from the Federal Housing Administration to determine if a condo is eligible for financing.
Next Steps to Get Your USDA Mortgage:
To determine if a USDA mortgage loan is right for you, it’s important to do a little research before talking with a lender.
Calculate your USDA mortgage payment.
Using MoneyGeek’s mortgage calculator, you can estimate how much your monthly loan payments could be to see.
Check the current mortgage rates.
Mortgage rates frequently fluctuate, so find out today’s mortgage rates to see how they will affect your USDA loan.
Determine what mortgage you can afford.
Lenders consider how much debt you have compared to your income to see if you have the funds available to pay your loan. Use MoneyGeek’s debt-to-income calculator to see how your DTI will fare.
About the Author
- U.S. Department of Agriculture. "USDA Celebrates 25th Anniversary of Single Family Housing Guaranteed Loan Program." Accessed February 10, 2021.
- U.S. Department of Agriculture. "Report to the President of the United States from the Task Force on Agriculture and Rural Prosperity." Accessed February 10, 2021.
- U.S. Department of Agriculture. "USDA Highlights Investments and Accomplishments in 2019 to Build Rural Prosperity." Accessed February 10, 2021.
- U.S. Department of Agriculture. "Rural Home Loans (Direct Program)." Accessed February 10, 2021.
- U.S. Department of Agriculture. "Single Family Housing Direct Home Loans." Accessed February 10, 2021.
- U.S. Department of Agriculture. "Single Family Housing Guaranteed Loan Program." Accessed February 10, 2021.
- U.S. Department of Agriculture. "Is Mortgage Insurance Required for Rural Housing Service Single-Family Loans?." Accessed February 10, 2021.