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USDA loans are a unique sort of mortgage. Aimed at encouraging homeownership in specific sections of the U.S., they offer some generous terms — but also some limitations, catering to a pretty specific sort of buyer.
Let’s explore what USDA loans are, their benefits and drawbacks, and who is eligible for them.
A USDA home loan is a type of government-backed mortgage, available to low- and moderate-income homebuyers in largely rural areas. Also referred to as rural development or RD loans, they 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.
USDA loans cater to this clientele in several ways. They are a no-down payment mortgage — you don’t have to bring any cash to the purchase, but can finance it completely. Along with no need for a down payment, USDA loans have another advantage: You could qualify for a modest, fixed interest rate if you have low income.
Some drawbacks, though, are that the property must be located in a USDA-approved area, and borrowers cannot earn more than a certain amount.
USDA eligibility requirements include:
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 immediately adjacent densely settled area, which is not part of or associated with an urban area.”
USDA mortgages are only available in these rural areas as part of a government initiative to promote homeownership and economic growth. These loans can help attract and retain people in these locations.
The USDA guaranteed 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: Sometimes you can earn as much as six figures. You can check income limits for your county and household size using the same property eligibility tool on the USDA website.
To prove income, you’ll need to provide the lender with documentation such as:
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.
Different types of USDA loans cater to different buyers, each with its own requirements and reasons for use.
The USDA guaranteed home loan program (officially known as Section 502 Guaranteed) allows approved mortgage lenders to provide 30-year fixed-rate loans to borrowers in USDA-eligible locations. It’s called a “guaranteed loan” because the USDA guarantees to reimburse up to 90 percent of the loan to the lenders in the event the borrower were to default on the mortgage.
Along with buying a home in a USDA-approved area, you’ll also need to meet an income requirement: no more than 115 percent of your area’s median household income (AMI). You can find income limits for your market using this tool.
Also known as Section 502 Direct, USDA direct loans offer low-rate home loans to individuals in rural areas in need of adequate housing. Unlike USDA guaranteed loans, you’ll apply for a direct loan through the USDA’s Rural Development Service Centers — not through a lender.
Direct loans are only available to households with low and very low income — you can view income limits here — and they must “be unable to obtain a loan from other resources,” according to the USDA. There’s also a limit on how much you can borrow — ranging from $398,600 to $919,800, depending on the county where the home is located. (You can view area loan limits here.)
Direct loans have a fixed interest rate, currently 4.75 percent, which can be reduced to 1 percent if you qualify for payment assistance. The loan terms range up to 33 years, or 38 years for very low income borrowers.
The USDA repair loan program (Section 504 Home Repair) is similar to the direct program in that it caters to low-income individuals. But it’s different in that it provides loans only up to $40,000 and only to help improve or fix a home — it’s not intended for purchasing a place. The program also offers grants to very low-income homeowners aged 62 or older to help remove hazards in the residence; these are capped at $10,000.
The major benefit of a USDA home loan is that it’ll cover the total cost of a home purchase, without mandating a contribution from the borrower. This can be a great boon for cash-strapped homebuyers. The drawbacks mostly have to do with the restrictions on where you can buy or how much income your family can have.
