Understanding USDA Loans: A Guide to Rural Homeownership

Owning a home is a dream many cherish, yet navigating the complexities of mortgage financing can often feel daunting. For those looking to buy a home in rural areas of the United States, USDA loans provide a unique opportunity that can make this dream a reality. These loans, backed by the U.S. Department of Agriculture (USDA), are designed to promote rural development by offering affordable financing options to eligible borrowers.

What is the USDA? 

The USDA is the United States Department of Agriculture. It was founded in 1862 to oversee farming, ranching, and forestry industries. The USDA is a department of the executive federal government and is made up of approximately 29 offices, employing about 100,000 people. They are focused on the above, as well as agriculture, food, natural resources, rural development, and nutrition. You may have guessed it, but rural development is where the USDA loan comes in. 

USDA Approved Lenders

What Are USDA Loans?

USDA or Rural Development loans are government-backed mortgages that offer favorable terms to encourage homeownership in rural and suburban areas. They are administered by the USDA’s Rural Development Guaranteed Housing Loan Program, which aims to enhance the quality of life in rural areas by offering affordable homeownership opportunities.

A USDA-approved lender is actually the financial institution where you get the loan, but the USDA insures the loan. This is a federally insured mortgage, similar to FHA and VA-backed loans. A USDA loan must be used in a rural area.

USDA loans approved areas are areas approved by the USDA. If you have considered living outside of a city or in a more rural area, this loan could be for you! Because these loans are backed by the US Government, lenders are more likely to work with individuals who have lower incomes. This reduces the financial risk of the lender because the government will insure 90% of the loan.

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Mortgage Insurance Guidelines on USDA Loans

With a USDA loan, you do not need to pay Private Mortgage Insurance (MPI). However, although you do not need a large down payment or even any down payment, you will have to pay the guarantee fee. This is an upfront and annually paid fee. This is in place of MPI. You might be asking yourself why it would be positive not to have to pay PMI but then be asked to pay the USDA Guarantee fee. Luckily, the USDA guarantee fee is much lower than MPI or FHA fees. The initial fee is only 1% of the sales price of the loan and can often be rolled into the loan amount. The annual fee is just .35 % of the balance of the loan. 

How To Know What Areas Qualify For USDA Loans?

The USDA has a definition of what a rural area is. They define it as a town, village, city, or place that is not within a highly populated metropolitan area with below 20,000 or open country and not a part of or associated with an urban area. If you go to the USDA website, you can check to see if the property qualifies based on its area. 

How Do You Qualify For USDA Loans?

Eligibility Requirements

To qualify for a USDA loan, borrowers must meet certain criteria:

• Location: The property must be located in a USDA-eligible rural area. Surprisingly, many suburban areas near major cities also qualify.
• Income Limits: Borrowers must fall within specified income limits based on location and family size. These limits ensure that USDA loans are targeted toward those needing the most assistance.
• Creditworthiness: While USDA loans do not have a strict minimum credit score requirement, lenders typically look for a credit score of at least 640 to qualify for streamlined processing.
• Ability to Repay: Borrowers must demonstrate a stable income and a reasonable income-to-debt ratio to show they can afford monthly mortgage payments.

Advantages of USDA Loans

1. No Down Payment: One of the most important benefits is the ability to fund 100% of the home’s purchase price without requiring a down payment.
2. Lower Interest Rates: USDA loans frequently provide more competitive interest rates than conventional mortgages, leading to potentially lower monthly payments.
3. Flexible Credit Guidelines: While more relaxed than conventional loans, USDA loans offer flexibility for borrowers with less-than-perfect credit histories.
4. Reduced Mortgage Insurance: USDA loans have lower mortgage insurance premiums than FHA loans or conventional mortgages with less than 20% down payment.

How to Apply

To apply for a USDA loan:

1. Find a USDA-Approved Lender: Research and choose a lender approved to offer USDA loans.
2. Gather Required Documents: This usually involves verifying income, reviewing employment history, assessing credit information, and obtaining information about the property you intend to buy.
3. Complete the Application: Fill out the lender’s application form and provide all necessary documentation for review.
4. Awaiting Approval: The lender will evaluate the application you submitted, and if it meets their criteria, they will forward it to the USDA for final approval.

What Is The Lowest Credit Score For USDA Loans?

Credit score: the lenders look for a credit score of 640 or above. However, the USDA does not set credit score minimums on loans; it’s the lender. This is because of the USDA Guaranteed Underwriting System (GUS). This is the USDA’s automated underwriting system which is an automated process of risk evaluation.

USDA Manual Underwriting Guidelines

Although a lower credit score will not disqualify you, it means that the lower credit scores require manual underwriting. What this means is that you were not automatically qualified for the loan but could still qualify with the help of other positive aspects- such as low debt, saved cash, etc.

There is also what is called non-traditional credit, or a “non-traditional tradeline.” Let’s face it- not everyone has the same life experiences and the same credit history.

If you wish to use a non-traditional tradeline, lenders will look at about a year’s worth of documents to show that you are paying your bills on time, such as rent, loans, car payments, insurance, tuition, etc. If you are unsure how to use a non-traditional tradeline, click here to talk to a loan officer who can assist you. 

USDA Employment History Guidelines

Employment history: Lenders will normally look at 1-2 years of your employment history. They are looking for stability and either consistent or improving pay scales. They will see if there are gaps in employment, which might signal issues with the ability to remain employed to pay off the loan. They generally look for gaps longer than one month within a two-year period. Now, if you have employment gaps longer than one month, do not give up. These can oftentimes be explained if there are valid reasons. Examples of reasons for gaps that would help you negotiate would be if you were in the military, went to school, or were taking care of an ill family member during the gap.   There are different loan types within the general USDA umbrella. 

USDA Guaranteed Loans

This loan is also called the Section 502 Loan. This helps lenders (remember they must be USDA-approved lenders!) give loans to buyers to purchase, build, rehabilitate, improve or relocate home with 100% financing in an approved rural area. This must be the primary home and not used for renting or an income property. The USDA will insure these loans with up to 90% guarantees. This also means that there would be no money down required if qualified. 

USDA Direct Loans

USDA Direct Loans is part of the 502 Direct Loan Program. These loans are different because they are funded directly by the USDA! The direct loan is for individuals who would otherwise be unable to secure financing through a lender. Applicants must be without decent, safe, or sanitary housing and not be in default or restricted from participating in a federal program (since the USDA is a federal agency). They also offer up to 100% financing and may include subsidized interest rates and payments based on the borrower’s income.

USDA Repair and Rehabilitation Loans

Also known as the Section 504 Home Repair Program, it allows low-income buyers to purchase a home. The difference between this and another USDA loan is that you can get funds for financing and also for repairs as one loan, which in turn reduces fees to an already low-income buyer.

USDA Renovation Loans

Many of the USDA homes already need renovation as they are more rural and possibly not kept up. This loan type allows for 100% of the financing needed for purchasing the home and an additional 2% of the value of the home for needed repairs. In order to qualify for this loan, you must be unable to get financing anywhere else.

Borrowers must have a low income- less than 50% of the median income for the area in which they live. Examples of how you could use the repair funds are to replace the flooring, fix or replace a bad roof, remove lead-based paint (Many of the older homes have lead-based paint), fix plumbing issues, or address heating or cooling concerns. 

USDA Rural Housing Site Loans

There are two types of loans that fall under this umbrella. First, there is the Section 523 Loan. This loan is used to buy and develop sites for use ONLY with the Self Help method. What is the Self-Help Program? Low-income borrowers team up with a non-profit public housing program to build one another’s homes. These buyers will build at least 65% of their own homes with a construction supervisor on site.

The Rural Housing Site Loans allow for private and public non-profit organizations to help them in buying a site and developing housing, again, for low-income families.

The second loan type that falls under the Rural Site Loan is Section 524 Loans. These, too, are for low-income families but have no restriction as to the method of construction. These loans can be for private or public non-profit organizations, the building site may be sold to low-income families, the non-profits have the legal authority to operate a revolving loan fund, and non-profits have the financial, technical, and managerial capacity to comply with federal regulation. This loan is also for federally recognized tribes.  

USDA Energy Efficient Loan

This loan type is geared towards lowering energy bills and reducing the negative effects of excess energy use. If the home you are looking to buy meets the International Energy Conservation Code ( IECC) energy efficient standards, a lender can offer $0 down. These standards include lighting and power systems that reduce the use of fossil fuels. Another bonus for this type of loan is that lenders see it as freeing up money that would otherwise be spent on utility bills to now be spent on repaying the mortgage. 

Can You Finance a Barn With USDA Loans?

Have you ever heard of a barndominium? This has increased in popularity through the years. Perhaps you do not want to buy a regular house. It doesn’t get much more rural than a barn! A barndominium is popular with home buyers because they have open floor plans, high ceilings, and many opportunities for customization.

Buying a Barndominium With USDA Loans

If you have thought about a barndominium, it may be possible to get the construction funded through the USDA. You will need to check the location and see if it is USDA eligible. This unusual home would need to be your primary residence and not an investment property, have an adequate roof, and be structurally sound. As with any residence that the USDA would look at, it will need to have fully operational heating and cooling systems, electrical systems, and suitable plumbing. If this is an entirely new build, you should use a USDA-approved builder for a USDA construction loan. 

Foreclosed properties

You can use a USDA loan to purchase a foreclosed property as long as it meets all the standard USDA guidelines. Homes that are in foreclosure are often in need of some maintenance and upkeep, and the residents must meet the HUD (Housing of Urban Development) guidelines. This includes, an example, that flooring has to be laid- there can’t be bare floors, electrical outlets must be GFI compliant, windows must be intact, roofs must have at least three years of life left, and paint can not be flaked. The good news is that with foreclosed properties, the sellers might be really motivated to sell!

Inspection and Appraisal

USDA does not require an inspection, but they do require an appraisal of the property you are buying. The appraiser is looking to see the value of the home and makes sure that the home you are buying is priced right. This is to protect the lender in case you default on the loan, and they need to sell it. They want to ensure that the property meets the USDA’s three S rules-

• The home is safe
• The home is sound
• The home is sanitary.

Things Appraisers Look For on an Appraisal of USDA Loans

Some examples of things the appraiser is looking for are square footage, home condition, access to the property (There is a paved or all-season road), and the number of bedrooms and bathrooms.

Any issues found during the appraisal need to be corrected prior to the loan closing.  

An inspector will be very thorough and look for issues such as foundation, heating, cooling, plumbing, pests, or floors. Unfortunately, the buyer pays for this inspection, but it is worth knowing what you are getting into.

Conclusion

USDA loans offer a significant opportunity for individuals and families to achieve homeownership in rural and suburban areas with favorable terms and conditions. Whether you’re a first-time homebuyer or looking to relocate to a more rural setting, exploring USDA loans could be the key to making your homeownership dreams a reality. By understanding the eligibility requirements, benefits, and application process, you can confidently take steps toward owning a home with the support of USDA loans.

Frequently Asked Questions (FAQs)

1. What is a USDA loan?
   A USDA loan is a mortgage loan program offered by the United States Department of Agriculture (USDA) to help low to moderate-income individuals or families purchase homes in eligible rural areas.
2. Who qualifies for a USDA loan?
   Eligibility for a USDA loan is based on factors such as income, location of the property, and credit score. Generally, applicants must have a stable income and meet certain income limits. The property they intend to purchase must be in an eligible rural area.
3. What advantages does USDA loans offer?
   Some benefits of USDA loans include 100% financing, no down payment required, competitive interest rates, and flexible credit guidelines. Additionally, USDA loans may offer lower mortgage insurance rates than other loan programs.
4. Can I use USDA loans to buy a home?
   USDA loans can only be used to purchase homes in eligible rural areas as defined by the USDA. These areas are typically outside urban centers and have populations of 10,000 people or less.
5. Do USDA loans require mortgage insurance?
   USDA loans typically require mortgage insurance, both an initial guarantee fee and a yearly fee. However, the upfront guarantee fee can be financed into the loan amount, and the annual fee is lower than other loan programs.
6. Are there any restrictions on the type of property I can purchase with a USDA loan?
   USDA loans can only be used to purchase primary residences, meaning the property must be owner-occupied. Additionally, certain properties, such as investment or income-producing properties, are not eligible for USDA financing.
7. How do I apply for a USDA loan?
   To apply for a USDA loan, you’ll need to find an approved lender that offers USDA loans and complete their application process. You’ll also need to provide documentation such as proof of income, employment history, and information about the property you intend to purchase.
8. How long does it take to get approved for USDA loans?
   The approval process for USDA loans may fluctuate based on variables like the lender’s current workload and the completeness of your application. Generally, getting approved for a USDA loan can take several weeks to a couple of months.
9. Can I refinance my existing mortgage with a USDA loan?
   USDA loans offer refinancing options for existing USDA loans and other types of mortgages. Refinancing with a USDA loan can help lower your interest rate or monthly payments or change the term of your loan.

You can contact us at Gustan Cho Associates by calling us at 800-900-8569 or text us for a faster response. You can also email us at alex@gustancho.com. Our expert Loan Officers are available even during weekends and holidays!

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