TABLE OF CONTENTS

    Homeownership can be expensive, but with the right mortgage, you can save thousands of dollars over the life of your loan.

    With so many options available for borrowers, home buyers may forget about government-backed programs like the USDA loan. USDA loans are guaranteed by the Rural Development Guaranteed Housing Loan program from the US Department of Agriculture (USDA) and can provide mortgage assistance to help you become a homeowner while spending less.

    With a USDA loan, you can expect a zero percent down payment in eligible rural towns. But is this loan right for you? Let’s discuss USDA loans, including their pros and cons, to help you make the right decision for you and your family.

    KEY TAKEAWAYS

    • USDA loans are guaranteed by the USDA and can reduce the costs of homeownership with no down payment requirements and lower interest rates.
    • A USDA loan is not for everyone; some borrowers won’t qualify based on their income, while others may choose a different type of loan so they’re not limited to rural locations.
    • The benefits of USDA loans include no down payment requirement, lower credit score requirements, competitive interest rates, and no PMI required for low or no down payments.

    What Is a USDA Loan?

    USDA loans are a type of mortgage assistance program that can reduce the costs of buying a home. These loans are designed for low- to moderate-income families who wish to purchase properties in rural areas and can be used to purchase or refinance an existing property.

    These loans are designed to help individuals who may not qualify for other types of home loans achieve their dreams of homeownership because they don’t require a down payment and have low interest rates and more favorable terms.

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    How Does a USDA Loan Work?

    There are two types of USDA loans. Guaranteed loans are issued through a private lender like Griffin Funding, while USDA direct loans are issued directly through the USDA. However, USDA direct loans typically come with more stringent requirements, and borrowers must be considered low-income and unable to obtain any other type of financial assistance.

    USDA loans make getting approved for a loan easier because they have more flexible lending criteria when you get them from a private lender. With these loans, you can get 100% financing and avoid needing a down payment while taking advantage of incredibly low interest rates.

    The USDA loan is only available for properties in rural areas, which are defined as places not part of an urban area with small populations. You can use the USDA map to find eligible areas that match these guidelines.

    When applying for a loan, USDA loans work similarly to other mortgage programs when you work with a private lender. However, unlike other loan options, USDA loans don’t have prepayment penalties.

    Like some other government-backed loans, you can’t use USDA loans for vacation investment properties; they can only be used for primary residences. However, you can use these loans to purchase any type of primary residence, ranging from newly built homes and foreclosures to condos and manufactured homes, as long as they’re located in a rural area.

    USDA Loan Qualification Requirements

    Since USDA loans are backed by the government, they have their own set of eligibility requirements in addition to your specific lenders’ requirements. To qualify for a USDA loan, you’ll need to meet the following requirements:

    Income

    USDA loans are designed for low- to middle-income families, so there are limits on how much you can earn. Your income can’t be more than 115% of the medium income in the area where you wish to purchase the property.

    Additionally, you must demonstrate your ability to repay the loan to your lender, which means having a stable source of income and a DTI of 43% or lower. Exact qualifications vary by lender.

    Credit score

    The USDA doesn’t set credit score requirements, so it’s up to the lender. Most lenders like to see a score of at least 640, but you may still qualify for a USDA loan with bad credit, depending on the lender and other factors.

    Debt-to-income (DTI) ratio

    Your DTI measures the amount of your gross income that goes towards paying your debts every month. Most lenders like to see a DTI of no more than 41%, standard with most types of loans. What this means is that no more than 41% of your income goes toward debts like existing mortgages, car and personal loans, credit cards, and so forth.

    Location

    The property must be located in an eligible rural area to qualify for a USDA loan. The USDA provides an interactive map that can help you search for areas or particular properties to determine their eligibility.

    Property size

    The size of the home can’t exceed 2,000 square feet to qualify for a USDA loan. However, there’s no property size, so your home can be situated on any amount of land.

    Safety requirements

    The property must be structurally sound, safe, and functional to qualify for a USDA loan. Lenders are required to hire an appraiser for USDA loan properties to assess the property to determine its market value and ensure it adheres to USDA property condition guidelines.

    In most cases, appraisers will be looking for a structurally sound home with a foundation and roof in good condition, allowing a family to move in as soon as possible. There should also be access to the home and HVAC systems in working order.

    They’ll also ensure the electrical system is safe with no exposed wiring and that the plumbing system is functional. Additionally, the home can’t have evidence of insect damage and must adhere to local and state building codes.

    FHA vs. USDA Loans

    USDA and FHA loans are two of the most popular government-backed loans because they reduce the costs of purchasing a home. However, they’re geared toward different types of borrowers. For instance, USDA loans are for borrowers looking to purchase property on rural land and are only available for low- to middle-income families.

    On the other hand, FHA loans, backed by the Federal Housing Administration, are more widely available for borrowers and properties of all types. There are no income restrictions with even more credit score requirement flexibility — scores as low as 550 are accepted. Additionally, USDA loans come with a zero down payment option, while FHA loans still require a down payment, although they can be as low as 3.5%.

    Borrowers who don’t qualify for USDA loans may still qualify for FHA loans. Additionally, these loans may be more appealing if you don’t want to be restricted to a certain area.

    Both programs are available for primary residences only, but with FHA loans, you can purchase multi-family homes with several units. Additionally, both allow for first-time home buyer grants to further reduce your costs of purchasing a home.

    Pros and Cons of USDA Loans

    With no down payment requirement and more flexible lending requirements, USDA loans are appealing to many borrowers. However, they’re not the right option for every home buyer. Learning the pros and cons of USDA loans can help you make the best decision based on your financial situation and long-term goals.

    USDA Loan Benefits

    USDA loan benefits center around saving money. The ultimate goal of this program is to help low- and middle-income families purchase property. As such, a few of the most significant benefits of USDA loans include the following:

    • No down payment required: Unlike other mortgage programs like FHA and conventional loans, USDA loans don’t require a down payment — a common barrier to homeownership. Instead, you can get 100% financing with a USDA loan without worrying about saving up for years.
    • Low credit score requirements: The USDA doesn’t have a minimum credit score requirement, but your lender does. Most lenders allow for a credit score as low as 600.
    • No PMI: Private mortgage insurance (PMI) is required for conventional loans when borrowers put down less than 20% to protect the lender in case of default. However, since the USDA provides a 90% loan note guarantee, effectively reducing the lender’s risk, there’s no need for PMI. These loans instead come with a guarantee fee, which consists of an upfront fee of 1% and an annual fee of 0.35% of your loan amount.
    • Competitive interest rates: USDA loans typically have lower rates than FHA and conventional loans because 90% of the loan is guaranteed, reducing a lender’s risk of lending to borrowers.
    • No reserves required: Some lenders require borrowers to have a few months’ worth of reserves depending on their credit score or DTIs. However, USDA loans don’t require reserves to show that you have enough money left over to cover several months of expenses.
    • No prepayment penalty: Some lenders charge a prepayment penalty if you pay your mortgage off early because it means you’ll pay more in interest. However, with a USDA loan, there are no prepayment penalties, so you can pay off your loan or sell your home as quickly as you want.

    USDA Loan Drawbacks

    Comparing USDA loan pros and cons can help you determine whether these loans are the best option. USDA loans aren’t the right option for all types of borrowers, so you should consider these drawbacks before purchasing a home:

    • Location requirements: USDA loans are only available for properties in rural areas, which means you may end up living in a less-than-ideal location. Since most people want to be close to their jobs and other conveniences, living in a rural area isn’t right for everyone.
    • Property type limitations: You can only use a USDA loan for primary residences. Income-producing investment properties or vacation homes cannot be purchased with a USDA loan.
    • Income limits: Even if you’re interested in living in a rural area, you may earn too much to qualify for a USDA loan. Borrowers must meet specific income criteria based on the location of the property. If you exceed those limits, you won’t qualify for the loan.
    • Guarantee fees: The upfront and annual guarantee fees can add thousands of dollars to your total mortgage bill, so it might not be the right loan option for individuals who can afford a larger down payment.
    • Longer underwriting times: USDA loans typically have a slower underwriting period because they need to check various details like your income and ensure the property’s location is considered rural according to the USDA’s standards. Additionally, they’ll need to hire an appraiser who can inspect the property to ensure it meets the USDA’s property requirements.

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    How to Get a USDA Loan

    When applying for a USDA loan you have two options: a guaranteed loan from a private lender or a direct loan from the USDA. To qualify for a direct loan, borrowers must be unable to secure financing using another method, so many home buyers won’t qualify. However, guaranteed loans from a private lender have less stringent requirements, so you may still qualify for a USDA loan.

    If you believe a USDA loan is right for you, follow these steps:

    Get pre-approved

    Every first-time home buyer checklist should include getting pre-approved for a loan. Getting pre-approval determines your eligibility for the USDA loan and the amount a lender is willing to let you borrow. Your pre-approval letter will give you a general idea of what you can afford, which can make shopping for a home easier and make you look more appealing to sellers.

    USDA loan lenders typically consider the front- and back-end DTI ratios. The front-end ratio calculates how much of your gross monthly income goes toward paying your mortgage, while the back-end ratio calculates how much of your income goes toward all your other monthly debts.

    Most lenders like to see a front-end ratio of 29% and a back-end ratio of 41% for a USDA loan. However, you may still qualify for a loan with a high DTI.

    What’s important to remember is that pre-approvals don’t guarantee that you’ll qualify for the loan. Since lenders don’t look at your financial situation in-depth until you submit your mortgage application, your eligibility and/or loan amount may change. Additionally, you’ll need to pass the USDA appraisal on the property to be approved for a loan.

    Find a home and apply for a loan

    Remember, USDA loans are only available for properties in rural areas. You can work with a realtor to help you search for homes in eligible areas or use the USDA’s map to find a home. Don’t assume a home isn’t eligible for a USDA loan based solely on its location. Instead, check the map to determine if a particular home matches the USDA’s criteria.

    Once you’ve found a home, you can complete an online application with your chosen lender and provide all the necessary information they need to verify your financial eligibility.

    Wait for underwriting

    Underwriting for a USDA loan can take longer than underwriting another type of loan because the property and borrower must adhere to certain guidelines. However, Griffin Funding aims to complete the underwriting process to give you loan approval in 30 days or less. During this time, we’ll review your financial documents to determine eligibility and your loan amount.

    Get an appraisal

    Once underwriting is complete, your lender will request an appraisal to determine the property’s market value and ensure it meets the USDA’s property requirements.

    Close on your loan

    Once your loan application is approved, you can set a date to close on the loan. Even though USDA loans don’t require down payments, you’ll still be responsible for paying closing costs, which are typically 2-6% of the loan value. Closing costs for USDA loans range from traditional costs like appraisal and origination fees to title insurance and taxes. However, there are also closing costs specific to USDA loans. The guarantee fee is an upfront 1% fee typically paid at closing. You can also choose not to pay it at closing and instead roll it into your loan.

    Additionally, if you purchase a home for less than the appraised value, you can roll some or all of your closing costs into your loan.

    USDA Loan Alternatives

    Many people don’t qualify for USDA loans because their income exceeds the 115% limit for the area where they want to purchase property. However, if you don’t have the money for a large down payment, you still have options for purchasing a home. Take a look at these USDA loan alternatives to find the right home loan for you based on your unique circumstances.

    FHA Loans

    We’ve already discussed how FHA loans work and differ from USDA loans. If you don’t qualify for a USDA loan, you may still qualify for an FHA loan and only be required to make a 3.5% down payment. While that number is higher than zero, it’s still affordable for most borrowers.

    FHA loans are best suited for borrowers with lower credit scores who can’t afford high down payments. You can be eligible for these loans with a credit score as low as 580. However, it’s important to note that while FHA loans don’t have a guarantee fee, they do require a mortgage insurance premium (MIP).

    MIP consists of an upfront payment and annual fee with amounts that vary depending on your total loan amount. The upfront fee is 1.75% of the loan amount and is due at closing, or it can be rolled up into your loan. How long you pay MIP depends on your down payment. The higher your down payment, the less you’ll pay in MIP. If you make a 10% down payment or higher, you’ll only pay MIP for 11 years. However, if you put down less than 10% at closing, you’ll pay MIP for the life of the loan unless you refinance to a conventional loan.

    VA Loans

    VA loans are guaranteed by the US Department of Veterans Affairs (VA) and come with benefits like zero down payment requirements, low minimum credit scores accepted, and limited closing costs. To qualify for a VA loan, you must be an eligible active duty service member, veteran, or surviving spouse. USDA and VA loans are very similar in their benefits, but you may qualify for one or the other depending on whether you served in the military.

    Additionally, like other government-backed mortgage programs, VA loans don’t come with private mortgage insurance. However, you’ll need to pay the VA funding fee, which can be as high as 3.6% in some cases. However, it’s a one-time cost versus upfront and annual costs, so it could potentially save you over the life of your loan, depending on the terms.

    One major difference between these two types of loans is that the VA limits the types and amount of closing costs a lender can charge a borrower. Non-allowable fees include prepayment penalties and attorney fees a lender can’t charge a borrower. Additionally, the amount the lender can charge for originating the loan is capped at 1% of the total loan amount.

    Conventional Loans

    Conventional loans are the most common type for first- and second-time home buyers because they’re fairly straightforward. While they come with more stringent lending requirements, they typically have competitive rates, and you can qualify with as little as 3% down. However, if you put down less than 20%, you’ll be required to pay PMI.

    Conventional loans are available for properties in any area, so you’re not limited to eligible rural areas. Additionally, they don’t have the same residence type restrictions, so they can be used for primary, secondary, or vacation homes and investment properties.

    Unfortunately, conventional loans can be more challenging to qualify for because they have stricter lending requirements, such as a minimum credit score of at least 620. Additionally, while USDA loans have income limits, there’s no maximum limit for conventional loans, but they come with loan limits dependent on your location.

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    Weigh the Pros and Cons of USDA Loans Before Applying

    Understanding USDA loan pros and cons can help you determine whether these loans are the best option based on your current financial situation and homeownership goals. While USDA loans can reduce the costs of homeownership, not everyone will qualify. Similarly, not everyone wants to purchase a home in a rural area.

    Wondering if a USDA loan is right for you or what your other options are? Contact Griffin Funding today. Our loan experts can help you determine the best home loan based on your unique situation and homeownership goals.

     

    Bill Lyons

    Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.