USDA loans are supported or funded by USDA and are designed to help low-income borrowers build or buy homes in eligible rural areas. Before applying for a loan, find out how to qualify for a loan, whether the advantages outweigh the disadvantages and what is the application process.
[Read: Best Mortgage Lenders.]
How do USDA loans work?
Borrowers can use the USDA Housing Loan to finance up to 100% of the property’s appraised value with no down paymentif they buy from specific locations.
Indeed, an important part of the USDA loan program is where you can buy your home. You will need to shop in a rural or suburban area with a population of less than 35,000, but that doesn’t mean it’s a farm.
“A common misconception about USDA loans is that they can only be used to buy farms,” said Ron Haney, senior vice president of mortgage finance policy at Independent Community Bankers of America.
You can also use a USDA loan to buy a single family home, townhouse, condominium, or even a manufactured home. In fact, much of the country is considered suitable for USDA lending, says Scott Fletcher, president of risk and compliance at Fairway Independent Mortgage Corp.
More shoppers are ready to relocate to rural and peri-urban areas thanks to the pandemic’s shift to teleworking, he said. “We spoke to the USDA office and they think this is happening with their volume,” says Fletcher.
Of course, borrowers with USDA loans can also save money in advance by waiving the down payment and interest rates are reduced compared to rates on ordinary loans… But you may need to pay mortgage insurance premiums that will protect the lender in the event of a default, and closing costs…
What Are the Types of USDA Loans?
Buyers can choose from two types of USDA loans:
Direct loans. The USDA funds direct loans that are set aside for low-income borrowers based on the median for their area. The loan term can be from 33 to 38 years, depending on income, and the interest rate can be reduced to 1% after the subsidies are applied. Borrowers generally do not pay a down payment and are not required to mortgage insurance premium…
Guaranteed loans. You must earn less than 115% of the region’s median income to be eligible for the USDA home loan guarantee.
Private lenders finance these mortgages, while the USDA insures 90% of each loan against default. This guarantee protects lenders by allowing them to offer mortgages at below market interest rates and no upfront payments.
But borrowers must pay two forms of mortgage insurance: an advance guarantee fee of 1% of the loan amount and an annual fee of 0.35% of the principal.
[Read: Best Mortgage Refinance Lenders.]
How can you qualify for a USDA loan?
When you apply for a USDA loan, the lender will check if you and the property meet your requirements. According to Fletcher, the qualifications are pretty standard.
“It’s a well-established program and there aren’t many loopholes in it,” he says.
For both guaranteed and direct programs, loan applicants must:
– Buy a house in a suitable countryside.
– Be a US citizen or non-citizen.
– Meet income requirements based on location.
– Agree to take the house as your primary residence.
– Show that they cannot get affordable credit elsewhere.
– Prove that they can participate in federal programs.
– Have an interface debt-to-income ratio 29% and server side ratio 41%. The back is how much of your monthly income goes towards paying off debts, and the front is the amount spent on your mortgage alone.
The property will also have to meet the following requirements:
– The house must be located in the countryside.
– The property must be of modest size for direct loans or common in the area for guaranteed loans.
– For a direct loan, the property cannot have an underground pool, the market value cannot exceed the loan limit set for the given area, and the house cannot be designed for income-generating activities.
– To qualify for a guaranteed loan, real estate must meet certain federal housing standards.
What are the rates for USDA loans?
Your rate will depend on the type of USDA loan you want. The USDA sets interest rates for direct loans based on the mortgage market, but does not participate in guaranteed loan rates.
The effective interest rate could drop to 1% after accounting for the USDA payment aid. On the other hand, individual lenders set rates on USDA-guaranteed loans “in the same way as for traditional mortgages, with the lowest rate being given to the borrower with the highest loan, and the lowest (loan-to-value ratio) and DTI, ”says Bill Parker. Director of Lending, Central Credit Union of Alabama.
Interest rates on USDA guaranteed loans are “very competitive with conventional mortgage products,” Parker adds.
Lenders can offer such low rates because the government guarantee protects the lender from losses.
Viewing and comparing USDA loan quotes can help you find the best deal. You can also get a better deal if you have a higher credit rating, even if you don’t need a minimum credit rating to qualify for a USDA loan.
How is the USDA loan application process going?
The exact process will differ depending on whether you are applying for a direct USDA loan or a guaranteed USDA loan. To get a direct loan, first contact your local Rural Development Office… You can shop from private lenders such as banks and credit unions for a guaranteed loan.
Here’s a general process that you can follow:
1. Get pre-approval for a USDA home loan. Before looking for homes, find a USDA approved lender and ask the lender to pre-approve a USDA loan for you.
The lender will review your income, debt and assets to see if you are eligible for the program. If you do, you will receive a pre-approval letter stating how much you can borrow.
2. Buy a USDA approved home. Look at the USDA property eligibility card… “You can use this map and overlay the appropriate areas on something like Zillow or Realtor.com,” says Fletcher. “Or find a property and then check to see if it is in a suitable area.”
3. Apply for a mortgage. Once you’ve found a home and the seller accepts your offer, you can select a USDA-approved mortgage lender and apply. You will provide documents proving your income, employment status, debts and assets during underwriting…
The lender is taking the extra step to make sure the borrower’s income is within the program’s limits, Fletcher said. “It is very important that the borrower provides information so that we can get this loan in (USDA) before settlement day,” he says.
4. Get approval from your local USDA office. The USDA will review your application and paperwork after the lender approves your loan. The agency will make sure that you and the property meet the requirements.
The timing of the closure depends on the lender, but the additional review adds at least a few days, Fletcher says. Once the USDA approves your loan, you can proceed to the final table where you sign the paperwork and pay your money to close.
[Read: Best FHA Loans.]
What are the pros and cons of USDA loans?
USDA loans may be a great option for some home buyers, but “consumers outside certain rural areas or above the income threshold are not candidates for USDA loans,” Haney says. Consider the pros and cons before submitting your application.
– A small amount of cash in advance is required. Most borrowers do not need to make a down payment. In addition, you can finance repairs, closing costs, and a loan security deposit, and sellers can contribute up to 6% of the sales price towards closing costs.
– Several loan options. USDA loans can be used to build, improve, relocate, buy or refinance a home.
– Flexible selection rules. You won’t need to meet the minimum credit rating requirements, and you can even qualify with an unconventional credit history. This may be someone who does not take out loans or use credit cards.
– No prepayment fees. Borrowers will not pay a commission if they pay off the mortgage ahead of time.
– Property restrictions. You will need to find a home in the countryside.
– Additional fee. USDA guaranteed loans come with an annual fee, although you can deposit it on the loan.
– Income restrictions. All adult family members must meet low income requirements.