What is a USDA home loan? Understanding the benefits and eligibility

What is a USDA home loan? 

The purpose of the USDA home loan program is to help very low- to moderate-income buyers purchase a home in a rural area. Since 1949, housing programs backed by the U.S. Department of Agriculture (USDA) have helped nearly 5 million families afford homes, according to the agency’s website. USDA loans support not only prospective buyers who might struggle to come up with a down payment, but also rural economies and communities by incentivizing homeowners to buy property there. 

These loans allow buyers to finance up to 100% of the home’s value, removing the burden of saving for a hefty down payment. USDA loans can also be used to repair or update a rural home. The USDA home loan program offers low interest rates, making these mortgages a good option for prospective homebuyers who have stable income and credit but might not meet other qualifications for a mortgage. 

Types of USDA loans

There are two main types of home loans the USDA administers: guaranteed and direct. Both are only available to buyers in eligible rural areas and offer competitive interest rates.

• Guaranteed loans: USDA-guaranteed loans are issued by a USDA-approved mortgage lender, such as a bank, mortgage broker, or credit union. The USDA guarantees up to 90% of the loan amount for lenders, which makes it less risky for them to lend a full 100% of the property’s value.    
  
  These loans are for borrowers earning up to 115% of the median income of the area in which they live. You can check the USDA’s website to review income eligibility rules and see if you qualify. The term for these loans is 30 years.
• Direct loans: The USDA acts as the lender for these mortgages, which are for very-low- to low-income homebuyers who are unable to qualify for other loans. Loans are processed through the local Rural Development Service Center. The terms for these loans are up to 38 years.   
  
  There are two types of direct USDA loans: 502 and 504 loans. A 502 loan is used to purchase an existing home, and a 504 loan allows the borrower to make updates or improvements on a home.

What are the requirements for a USDA home loan?

To qualify for a USDA home loan, review the agency’s guidelines for location, type of home, and income maximum. Here’s what these mortgages require:

• Location eligibility: Unlike other types of loans, the program is focused solely on building up rural communities, so you can only use a USDA mortgage to buy a home in a designated rural location. Some suburban locations are also eligible, so check the USDA home loan eligibility map to see if your property qualifies. 
• Income eligibility: These loans are designed to help first-time homebuyers and lower-income borrowers who might need a little help to get into a home. Both direct and guaranteed loans have limits on how much you can make to qualify. These limits vary by county and family size.
• Credit score: The USDA doesn’t have a declared minimum credit score for its direct loans. Guaranteed loans are processed by a commercial lender, which will likely have its own minimum credit score requirements. For most lenders, this is around 640.
• Debt-to-income ratio (DTI): The USDA verifies that applicants can repay their loans by ensuring their debt-to-income ratio is no more than 41%. The agency further requires borrowers to spend no more than 29% of their income on housing expenses. 
• Occupancy: By using a USDA mortgage, you agree to occupy the home as your primary residence throughout the loan’s term. You must move in within 60 days of closing.

What are the benefits and drawbacks of a USDA home loan? 

For rural homebuyers who don’t have much saved for a down payment, a USDA mortgage with 100% financing could be ideal. While there are many USDA loan benefits, this program is not for everyone. Here are a few pros and cons of USDA mortgages:

Pros

• No down payment: Most USDA loans do not require a down payment, though you’ll likely still have to cover closing costs. These include origination fees, title fees, and other charges.
• Can use funds for repairs: A USDA 504 direct loan can be used to cover the costs of repairing or updating a home.
• Low interest rates: USDA loan interest rates tend to be lower than typical mortgage interest rates, particularly for direct loans.
• No PMI: Most mortgages that have a loan-to-value (LTV) ratio greater than 80% require the borrower to pay private mortgage insurance (PMI) each month. However, USDA loans do not have this requirement.
• Flexible credit score requirements: USDA doesn’t have a minimum credit score requirement, though lending partners can set their own. 

Cons

• USDA loan fees: While USDA does not require PMI, it does charge an upfront fee of 1% of the loan amount, which is due at closing. It also charges an annual fee of 0.35% of the remaining loan balance for the life of the loan.
• Only usable in designated rural areas: The eligibility map will limit what properties you can buy with a USDA mortgage.
• Income limits: These mortgages are designed for low- to moderate-income borrowers, so if you make more than 115% of the area’s median income, you will not qualify for this type of loan.
• Property restrictions: USDA loans are for modest homes, so certain features (such as square footage above 2,000 or an in-ground pool) will make the home ineligible for this type of mortgage.
• Occupancy requirements: You must occupy the home as your primary residence within 60 days of closing, so USDA loans cannot be used for second homes or to finance a rental property.

Who is eligible for a USDA home loan? 

To apply for a USDA home loan, you must be a U.S. citizen, U.S. non-citizen national, or qualified alien. Your household income must not exceed the USDA loan income limits for your area. These are based on household size, and you can check your income eligibility on the USDA website. 

How to apply for a USDA home loan 

How you apply for a USDA loan depends on which type of loan (direct or guaranteed) you want to get. Guaranteed loans are available through the USDA’s list of approved lenders, whereas you apply for direct loans through your local USDA Rural Development office. If you’re not sure what type of loan you qualify for, you can use the USDA’s assessment tool to find out.

To apply for a guaranteed USDA loan, you largely follow the same steps as you would for a conventional mortgage:

1. Get pre-approved: Shop around to find at least three different lenders and compare rates and terms. Even though the USDA home loan program is administered by the government, lenders have their own requirements.
2. Make an offer: Your real estate agent can help you negotiate the terms of the sale with the seller.
3. Fill out a full loan application: This includes submitting documents to prove your identity, income, assets, and other financial indicators. 
4. Get an inspection and appraisal: The lender will require an appraisal before they will lend against the property. While the inspection may not be necessary, it’s strongly recommended so you understand any problems the home has before you buy it.
5. Wait for underwriting: The lender double-checks all the documents you send them for accuracy and determines the final terms of your loan. 
6. Close the loan: Review the closing disclosure so you know what to expect at the closing table. Sign on the dotted line, and the home is yours.

USDA home loan FAQ 

How much can I borrow with a USDA home loan?

The maximum loan amount for a USDA home loan varies by county. Areas with higher cost of living and elevated real estate prices have higher maximums allowed. The borrowing limits for 2024 start at $398,600 and go up from there. You can find a list of loan limits for each county on the USDA’s website. 

Does a USDA home loan require a down payment?

Applicants with higher assets than the allowed limit may be required to use some of their money for a down payment, but it’s not required if you don’t have the funds. Borrowers may still be responsible for closing costs, however.

What is the USDA home loan income limit?

For guaranteed USDA loans, your household income cannot be more than 115% of the area’s median income (or AMI). For direct USDA loans, your household income cannot exceed 80% of the AMI. 

Can I use a USDA home loan for a vacation home?

No. USDA mortgages are for primary residences only.