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Home prices have spiked in recent years, with the FHFA Home Price Index reaching 657.32 in Q3, 2023, compared to 462.26 just three years prior.
As home prices rise, so do the down payment needs. For example, the typical 5% down needed on a $400,000 conventional loan is $20,000, not including the added figures for closing costs, which can easily exceed $10,000.
Many homebuyers don’t have the cash reserves for that kind of investment, leaving them looking for ways to save for a down payment. One compelling option for rural homebuyers without significant cash reserves is the USDA loan – a home loan program that doesn’t require a down payment.
What is a USDA Loan?
The USDA Loan, administered by the United States Department of Agriculture (USDA), is a mortgage program that promotes homeownership in rural areas. USDA loans come from private lenders, banks and credit unions and are insured by the USDA.
USDA loans offer several advantages, including:
- Zero down payment: Unlike conventional and FHA loans, the USDA loan allows qualified borrowers to purchase a home without a down payment. This significantly reduces the upfront cost of homeownership.
- Competitive interest rates: USDA loan interest rates are typically in line with or slightly below conventional rates, making them an attractive choice for budget-conscious borrowers.
- Flexible credit requirements: While good credit is still preferred, the USDA program is more lenient towards borrowers with credit blemishes than traditional lenders.
Downsides of USDA Loans
The benefits stand out but don’t tell the entire story. It’s important to consider the following aspects of the USDA loan:
- Income limitations: The program targets low and moderate-income families. To qualify, your household income cannot exceed 115% of the median income in your area.
- Geographic restrictions: The loan is only available for properties located in eligible rural areas. The USDA designates these areas, encompassing a substantial portion of the United States.
- Property restrictions: The USDA loan has stricter property requirements than conventional loans. The property must be modest in size and value and meet specific health and safety standards.
- $0 down payment: A double-edged sword is the $0 down option. Borrowers who put $0 down start with little-to-no equity in their home, which could cause issues if home values plummeted.
» MORE: See today’s refinance rates
USDA Loan Eligibility
While the program offers enticing benefits, it’s important to understand whether you meet the requirements. To be eligible for the USDA loan program, you must meet several criteria:
Be a U.S. citizen, U.S. non-citizen national, or a qualified alien.
Have an adjusted household income that falls at or below 115% of the median income for the area where you plan to purchase a home.
The USDA income limit varies depending on the location and family size. You can check the USDA website or consult a lender to determine the specific income limit for your desired area.
To be eligible for a USDA loan, you must intend to occupy the property and live there as your primary residence. The general rule is you must live in the home for a majority of the year.
While credit score requirements are often more lenient to get a good rate, most lenders still require a 640 credit score. 640 is the cut off for the Guaranteed Underwriting System (GUS), the USDA’s automated underwriting system. While a 640 is typical, some leners may consider lower credit scores with a manual underwrite if they bring compensating factors to the table to offset the credit score.
5. Property location:
As previously mentioned, the property must be in an eligible rural area. USDA designated rural areas are typically fewer than 35,000 people.
You can use the USDA’s eligibility map to determine if the property is located in a qualifying area.
6. Property type:
The property must be a single-family dwelling, meaning it cannot be a multi-unit or commercial property. The property must also meet specific health and safety standards set by the USDA.
Who Should Consider a USDA Loan?
The USDA loan is an excellent option for qualified borrowers who meet the income and geographic requirements and:
- Have limited savings for a down payment.
- Have good credit but may not meet the strict credit score requirements of conventional loans.
- Seek a competitive interest rate.
Conversely, you may be better suited for a different mortgage program if you have a high income, especially if you exceed the USDA’s income limits. The USDA loan is also not a good fit if you want to purchase farmland, investment properties, or live in a larger city.
Additional Points to Consider:
- Closing costs: While the USDA loan eliminates the down payment requirement, closing costs are still associated with the purchase. Be prepared to cover these expenses.
- USDA guarantee fee: The USDA charges an upfront and annual guarantee fee to USDA borrowers. The upfront fee, which can be rolled into the mortgage, is 1% of the loan amount. The annual fee, also rolled into the loan, is 0.35% of the loan amount. These charges add to the overall cost of the loan.
- Pre-approval process: Obtaining pre-approval for a USDA loan can be more complex than with conventional loans. It’s crucial to work with a lender who is experienced with the USDA program.
Ultimately, the decision to pursue a USDA loan depends on your individual circumstances and financial goals. Weigh the benefits and drawbacks carefully and consult with a mortgage loan officer to determine if this program is the right fit for you.