In a Nutshell
USDA loans can be used to buy or repair an eligible home in a rural area. They’re designed for people with income below certain limits who can’t find another affordable loan.What is a USDA loan?
A USDA loan is a special type of mortgage or grant given out to help rural, lower-income residents buy or repair a home. The USDA loan program is run by the Rural Development office of the U.S. Department of Agriculture (hence the name), and it offers several different options depending on your circumstances and what you need help with.
Each is meant to assist people who wouldn’t qualify for other types of home loans to buy, build or make repairs to a home in a rural area.
Though eligibility isn’t limited to first-time homebuyers, these loans can be especially helpful if it’s your first time out, because USDA loans generally don‘t require a down payment.
We’ll go over the different types of USDA loans and look at their eligibility requirements. We’ll also compare USDA loans with FHA loans, and we’ll review a few questions to think about before applying for a loan from the USDA.
- How do USDA loans work?
- Types of USDA loans
- Who qualifies for a USDA loan?
- Is a USDA loan or an FHA loan better?
How do USDA loans work?
You can only get a USDA loan if you live in a rural area, as determined by the USDA. The USDA considers a particular “town, village, city or place” to be “rural” (and therefore eligible for a USDA loan) if it has a population below 10,000 people. These areas are reassessed every five years to see if they’re still eligible.
Some metropolitan areas can be included too, if between 10,000 and 20,000 people live there and people with moderate-to-low incomes have an overall harder time obtaining mortgages.
The USDA reassesses the eligibility of some areas that are growing more quickly on a more frequent three-year basis.
Types of USDA loans
The U.S. Department of Agriculture offers three types of loan programs to people who want to buy or repair a single-family home in a rural area.
These programs are intended to help people who otherwise couldn’t afford to buy a home or continue living in an existing home. The USDA also says it has the broader goals of supporting community well-being and bolstering rural economies.
Each type of loan works a little differently.
Section 502 direct loans
Through its Single Family Housing Direct Home Loans program (also known as Section 502 direct loans), the USDA lends money directly to homebuyers. Some people who take out direct loans from the USDA also qualify for payment assistance, which temporarily lowers the monthly payment they owe.
If eligible, you can use these loans to buy an existing home, and even repair it, if needed. You can also use the money to build a new home.
You don’t have to make a down payment, unless your assets are above a certain threshold. Another plus: You don’t have to pay for mortgage insurance.
The loans have a fixed interest rate that’s determined by market rates. If you qualify for payment assistance, the effective rate can be as low as 1%. Loan terms are typically 33 years, though borrowers with very low income may have up to 38 years to repay the loan.
The loan amount is determined by your income, assets, debt-to-income ratio and other financial details, but it can’t be higher than the USDA’s loan limit for the area. And this type of loan can’t be used to buy or build a home that’s unusually large or valuable for its location, that has an in-ground swimming pool, or that’s constructed to serve as the site of a business or to generate income.
USDA-guaranteed loans
The USDA guarantees some loans offered by private lenders through its Single Family Housing Guaranteed Loan program (Section 502 guaranteed loans). These loans can be used to buy an existing home, as well as cover the costs of repairing or improving it. They can also be used to build a new home or to refinance another USDA-guaranteed loan or Section 502 direct loan that the homeowner previously took out.
USDA-guaranteed loans don’t require a down payment. And while you don’t have to pay for mortgage insurance, these loans come with a yearly “guarantee” fee that’s worked into your monthly payments.
USDA-guaranteed loans can be as much as 100% of the appraised value of the home. If the sale price is less than that, the homebuyer can use the difference to cover repairs or pay closing costs, the costs of setting up utilities or some other expenses related to the purchase.
The participating private lenders determine what interest rates to offer, but they have to stick to fixed-rate loans with 30-year terms.
To be eligible, a home needs to be a single-family dwelling (which can include a house, condo, or modular or manufactured structure) that meets standards set by the Department of Housing and Urban Development. And it can’t be on a lot that’s particularly large for where it’s located.
USDA housing repair loans
Loans offered through the Section 504 Home Repair program are meant to provide funds to bring homes up to date, make needed repairs, or eliminate health hazards and safety risks. For example, loans may be used to fix structural issues or to connect a home with a water or sewer line. These loans also may be used to install or fix a heating system, put in a new roof or insulate the home so it can be lived in comfortably during the winter.
Loans amounts can’t be more than $20,000, and borrowers have 20 years to pay the loan back. The interest rate stays at 1% for the life of the loan. The program also makes grants available for the same use for eligible people who are at least 62 years old and can’t afford to repay a loan.
Who qualifies for a USDA loan?
To get a USDA loan, the home you want to buy or repair must be in an eligible area. Homes usually need to be located in an area where the population is below 20,000, though in some cases homes in areas with a population as high as 35,000 are eligible.
There are other requirements that vary depending on the type of loan you’re applying for.
- Section 502 direct loans — Applicants need to have income no higher than the USDA’s low-income limit for the county where they’re buying or building a home. They also have to be able to show that they can pay back the loan. They must plan to use the property as their primary residence, and they can’t already have other housing lined up or have the option to take out a reasonably good loan from a different source.
- USDA-guaranteed loans — Applicants need to have household income that isn’t more than 115% of the median income. They have to show that they can repay a loan, but it’s OK if they have alternative proof of credit history in place of conventional credit reports and scores. They need to plan to use the property as their primary residence, and they must be unable to get a no-PMI (private mortgage insurance) conventional loan.
- USDA housing repair loans — Applicants need to own the home and be living in it. Their income has to be less than 50% of the median income for their county, and they must not be able to find a loan they can afford from another source.
Location requirements
To qualify for any USDA loan, you’ll need to live in an eligible area. Luckily, the USDA has an eligibility map that you can use to check your area’s eligibility for each type of USDA loan. You’ll just need to enter your property address to get a quick answer on whether your prospective home is in an eligible area.
Is a USDA loan or an FHA loan better?
USDA loans and FHA loans each have pros and cons. Which one is better for you depends on your circumstances.
A USDA loan may be less costly than an FHA loan, so it’s worth considering a USDA loan first if you meet the eligibility requirements. USDA loans typically don’t require down payments, making them attractive to homebuyers who don’t have much money saved up. FHA loans, on the other hand, require down payments starting at 3.5%.
Direct loans from the USDA don’t require you to pay for mortgage insurance, while FHA loans require monthly mortgage insurance as well as a one-time mortgage insurance premium upfront.
But FHA loans don’t have income-eligibility caps like USDA loans do, so they’re available to people with a wider range of incomes. And you can use an FHA loan to buy an eligible home anywhere in the U.S., unlike USDA loans, which are restricted specifically to rural areas that meet population thresholds.
You aren’t excluded from any geographic location with an FHA loan, though the maximum amount you can borrow varies by county.
What’s next?
Here are some questions to ask before you apply for a USDA home loan.
- Is the property you’re interested in located in an eligible area? Search the USDA’s map to confirm the address is eligible for a loan.
- Do you qualify for a grant instead of a loan or in conjunction with a loan? Homeowners who are 62 or older and who don’t have the means to pay back a repair loan may qualify for a repair grant from the USDA. Grants can be as large as $7,500 and are only for eliminating dangers to health or safety.
- Could you get affordable financing from a conventional lender? USDA loans are available only to people who can’t find another acceptable loan. You may want to ask for quotes from a few lenders to confirm that conventional loans are, in fact, out of reach for you.
FAQs
USDA loans can be costly, with a 1% upfront funding fee (which can be rolled into your loan) and a 0.35% annual fee. It also may be harder to qualify for these loans because you’ll need to meet income and credit requirements, and your home must meet certain conditions, too.
If you can’t qualify for a mortgage otherwise and you meet the requirements, a USDA loan can be a good option, as long as you can afford the monthly mortgage payments and other homeownership costs. A USDA loan is typically cheaper than an FHA loan, another common government-backed loan for low-income people.
A USDA loan helps low-income and moderate-income people in rural areas afford a home or pay for home repairs. It’s part of the Department of Agriculture’s overall strategy to develop rural areas.
The FHA loan program is run by the Federal Housing Administration and helps people who have low credit scores and limited savings buy a home, regardless of where it’s located. The USDA loan program is run by the U.S. Department of Agriculture, on the other hand, and is limited to lower-income rural residents. All things being equal, FHA loans tend to be more expensive than USDA loans.
There are no minimum required credit scores for USDA loans. However, you’ll need to show that you can’t afford or aren’t eligible for a conventional loan in your area, which does typically limit it to people who have poor credit.
The USDA Guaranteed Loan program is only available to people earning a low- to moderate-income, defined as being below 115% of your area’s median household income (available here). The USDA Direct Loan program, on the other hand, is only available to people earning a low- or very-low-income (available here).
Depending on the type of USDA loan you’re applying for, you’ll be considered eligible if you live in a rural area, aren’t able to get a conventional loan and earn a moderate or low income. Your property must meet certain requirements, too, such as being your primary residence.
The USDA loan program is run by the U.S. Department of Agriculture and is designed to help low-income residents in rural areas afford homeownership. The VA loan program is run by the U.S. Department of Veterans Affairs and is designed to help veterans and active-duty service members afford the costs of homeownership. A VA loan tends to be cheaper because it doesn’t carry as many fees as a USDA loan.
The USDA loan program has strict rules that are set up by the U.S. Department of Agriculture, and are designed to help people with low incomes, sparse savings and some credit issues afford homes (people who typically have trouble qualifying for a conventional mortgage). Conventional loans are offered by individual lenders and usually require good credit, larger down payments and strong incomes to qualify.