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What is a USDA loan?
A USDA home loan is a no-down payment mortgage for low- and moderate-income homebuyers in largely rural areas. USDA loans are part of a national program created by the U.S. Department of Agriculture to help create loans for first-time homebuyers or people who don’t meet conventional mortgage requirements. They are sometimes referred to as rural development or RD loans.
The benefits of a USDA mortgage include no need for a down payment and looser credit requirements. Some drawbacks are that the property must be located in a USDA-approved area and borrowers cannot exceed income limits.
Types of USDA loans
- USDA guaranteed – The USDA guaranteed home loan program (officially known as Section 502 Guaranteed) allows approved mortgage lenders to provide 30-year fixed-rate USDA loans to borrowers within certain income thresholds in specific USDA-eligible locations
- USDA direct – Also known as Section 502 Direct, this program offers low-rate home loans to individuals in need of adequate housing. Like the guaranteed program, borrowers have to meet certain eligibility criteria to qualify.
- USDA repair – The USDA repair loan program (Section 504 Home Repair) is similar to the direct program in that it caters to low-income individuals, but different in that it provides loans up to $20,000 to help improve or repair a home. There are also grants available to very low-income elderly homeowners to help remove hazards at home. These are capped at $7,500.
USDA home loan requirements
The easiest way to find out if a home is in a USDA-eligible area is to check the USDA website. Homes purchased with USDA loans must be located in eligible rural areas. The USDA defines these areas as “open country or any town, village, city, or place, including the immediate adjacent densely settled area, which is not part of or associated with an urban area.”
The USDA loan program is geared toward low- and moderate-income homebuyers. For this reason, applicants can’t earn more than certain income limits, which vary by metro area and family size. In more expensive areas, the income ceiling is higher. You can check income limits for your county and household size using the same property eligibility tool on the USDA website.
Credit score requirements
The USDA doesn’t impose a blanket credit score requirement for all borrowers, but typically, USDA-approved lenders look for a score of at least 640.
USDA loan fees
USDA mortgages come with two fees that are specific to the program:
- Upfront guarantee fee: The upfront guarantee fee this fiscal year is 1 percent of the loan amount. This fee can often be rolled into the mortgage instead of paying it out of pocket.
- Annual fee: The annual fee is 0.35 percent of the loan amount. A $100,000 mortgage, for example, would have a $1,000 one-time payment and a $350 per year ongoing payment for the life of the loan.
Both of these fees are charged to the lender who then, usually, passes the cost on to the borrower. These fees keep USDA loans subsidy-neutral, which means that any losses incurred by the program are paid for by these fees instead of taxpayer dollars. Depending on the needs of the program, the fees can change annually.
Other USDA mortgage costs
- Origination fee: Many lenders charge an origination fee on mortgages, regardless of loan type. The fee usually costs around 1 percent of the amount you’re borrowing.
- Loan application fee: Similar to applying for college, some lenders charge a nominal fee to complete the mortgage application.
- Title insurance and services: When you buy a home with a mortgage, you’ll be required to pay for a title search and lender’s title insurance policy. The cost varies depending on the closing attorney or settlement or title company you work with.
- Processing or underwriting fees: In addition to (or sometimes in lieu of) an origination fee, some lenders charge a “processing” or “underwriting” fee. This cost covers the expense of underwriting your loan application.
- Credit report fee: Many lenders charge a small fee to run a credit check.
- Appraisal: As the homebuyer, you’ll be responsible for paying for the home to be appraised before the lender can approve your loan. An appraisal typically runs about $350 to $400.
- Discount points: Many lenders offer the option to purchase mortgage points to buy down your loan’s interest rate. One point costs 1 percent of the amount you’re borrowing.
Pros and cons of USDA loans
The benefits of a USDA home loan include less stringent credit score guidelines and no down payment requirement. There is also no formal loan limit, unlike FHA loans. This can be a great program for homebuyers on a budget who are flexible about where they live. The cons mostly have to do with restrictions, like those on where you can buy or how much your family can make.
- No down payment required
- Lenient credit score requirements
- Seller can pay the closing costs
- Available for both purchasing property and refinancing
- Often come with low, fixed interest rates
- Strict guidelines around where property is located
- Must use home for primary residence
- Limited income requirements
- Upfront and annual fees
USDA vs. other types of loans
USDA loans aren’t the only government-insured mortgage out there. If you’re not eligible for a USDA loan, you might be for an FHA or VA loan, or even a conventional loan. Here’s an overview of some key differences between these types of loans:
|USDA loan||Conventional loan||FHA loan||VA loan|
|Credit requirements||None, but 640 is standard||620||580||None unless lender requires|
|Debt-to-income (DTI) ratio requirements||Up to 41%||Up to 43%||Up to 50%||Up to 41%|
|Down payment requirements||None||3% or 5%||3.5%||None|