What is a USDA loan, and am I eligible?
USDA loans allow people to buy modest homes in eligible areas
If you make less than the median income in your area and you have a desire to own property in rural America, then you and your family are likely eligible for a mortgage loan backed by the U.S. Department of Agriculture's Rural Development Guaranteed Housing Loan program, referred to as a USDA loan or Rural Development loan. Occasionally, USDA loans are called Section 502 loans, after section 502(h) of the Housing Act of 1949, which makes the USDA’s loan programs possible.
USDA loans were created to encourage growth in rural communities across the United States. The USDA considers any areas that are not part of an urban area to be a rural area, including many suburban communities. In fact, about 97 percent of land in the country is considered “rural.”
What is a USDA loan?
USDA loans encourage homeownership for people in rural communities who have trouble qualifying for other, more traditional mortgage loans. Loan funds can be used to purchase, renovate or refinance a house in a rural or suburban area.
The USDA Rural Development’s housing program guarantees single-family housing loans for low- and moderate-income earners in rural areas. “Guarantee” doesn’t mean that every applicant will qualify, but rather that the USDA will reimburse lenders if a borrower defaults on the loan. Because the government takes on all the risk of the loan, lenders are able to offer low-interest rate loans, even without a downpayment.
How does a USDA loan work?
You can get a USDA loan from private banks and mortgage lenders. Unlike traditional mortgage loans, to be eligible for a USDA loan, you must meet certain restrictions relating to your income and location, and the home for which the loan is issued must be owner-occupied. All USDA loans come with 15- or 30-year fixed rates.
Before you can be approved for a USDA loan, a lender will evaluate your credit history and repayment patterns to determine if you’re eligible. Eligible homebuyers can qualify for up to 100 percent financing, meaning they won’t have to make a down payment at all. USDA loan options include loan guarantees, direct loans and home improvement loans:
- Loan guarantees
You can use a USDA loan guarantee to build, improve or relocate your home in an approved rural area. To be eligible for a USDA loan guarantee, you need a 620+ credit score and less a debt-to-income ratio less than 50 percent.
- Direct loans
Low- and very low-income thresholds to qualify for a USDA direct loan vary by location, but typically you must make 50–80 percent of the average median income for your area. Federal subsidies make it possible for interest rates to be as low as 1 percent, and terms can last up to 38 years. Properties financed through direct loan funds must generally be less than 2,000 square feet and worth less than the loan limit for the area. The property cannot be designed for commercial activity or include an in-ground swimming pool.
- Home improvement loans
As part of the USDA’s goal to make safe and sanitary housing available to low-income families in rural communities, home improvement loans and grants can be used to repair or replace roofs, floors, HVAC units and more. Sometimes called a 504 loan, these loans are for adults 62 and older who need funds for important home repairs and improvements. To qualify, you must make less than 50 percent of the average income in your community. Loans are available up to $20,000, and grants are available up to $7,500.
USDA eligibility requirements
In a lot of ways, applying for a USDA loan is like applying for any other mortgage loan. You must prove your ability to repay, usually with pay stubs and tax returns, and also meet the USDA’s other eligibility requirements: your income must be significantly less than the median income in your area, and the property you finance with a USDA loan must meet certain criteria.
USDA loans aren’t reserved for first-time homebuyers—anyone can apply. Since USDA loans were created for prospective homebuyers outside of urban areas who have trouble qualifying for more traditional mortgage loans, qualifying for a USDA loan is usually easier than qualifying for other mortgage loans. USDA loan eligibility depends on a variety of factors:
- U.S. citizenship status
USDA loans are available for U.S. citizens, U.S. nationals and qualified aliens or lawful permanent residents. To qualify for any USDA loan, you’ll have to prove your citizenship status with a government-issued photo ID, birth certificate, alien registration card or your naturalization/citizenship certificate.
- Meet the USDA income limit
In 2019, the USDA increased income limits for loan applicants. For most rural locations, the gross income limit is $82,700, with larger households of five or more at $109,150. However, income eligibility requirements vary by area. The USDA defines “moderate income” as no more than 115 percent of the median family income in the United States, or 115 percent of the state-wide average of medium incomes across counties.
For example, a four-person household with one working adult in Kuaui County, Hawaii, is considered low- to moderate-income if they earn less than $55,000–$112,900 per year. The same family in Barbour County, Alabama, qualifies as low-income if they make less than $27,150 per year, or moderate-income up to $82,700 per year.
Households earning low or very low incomes may qualify for a USDA direct loan. The USDA defines “low income” as between 50–80 percent of the local area median income (AMI) and “very low income” as below 50 percent of the local AMI.
Keep in mind that when the USDA evaluates a family’s income, they take into consideration everyone in the household, not just the applicant or co-applicant. For instance, if your teenage daughter has a part-time job, you’ll have to disclose her wages as part of your household income. You will, however, receive credits for documented childcare expenses, as well as expenses related to household members with a medical condition or elderly parents who live with you. You’ll be able to claim a $480 credit for every child under 18 and every child who is a full-time student, and you can claim a $400 credit for every adult in the household over 62.
- Minimum credit score for USDA loans
If your credit score is 640 or higher, your USDA loan application process will be streamlined. Keep in mind that lenders consider more than just your credit score. Even if your credit score is somewhere between 620 and 640, you could still qualify, but you’ll be required to meet other, more strict, underwriting standards.
If your credit score is below 640 and you have outstanding credit card balances, you should try to pay those down before you apply for a USDA loan. This will improve your credit utilization ratio, which represents the maximum amount of credit you have access to compared to what you are actually using. Getting your credit utilization ratio below 20 percent will increase your chances of qualifying for a USDA loan.
- Maximum debt-to-income ratio for USDA loans
Most of the time, USDA loan lenders won’t accept an applicant with a debt-to-income ratio (DTI) greater than 50 percent. To calculate your DTI, simply add your monthly debt payments and divide by your gross monthly income.
You often hear USDA lenders talk about front-end and back-end DTI. When evaluating your ability to repay, a lender will also take into consideration your PITI ratio, which stands for principle, interest, taxes and insurance, plus all other payments you’re obligated to make each month, including student loans, credit cards, vehicle payments and co-signed loans. This is why USDA lenders express DTI as two numbers. The first number, or front-end DTI, is your PITI ratio.
- Meet USDA loan limits
There is set no maximum amount for a USDA guaranteed loan. The limit to how much you’ll be able to borrow is determined by lenders based on your credit history, payment history, assets, savings, debts and income
On the other hand, USDA direct loan limits vary by county and are based on the median home price for that area. This is why in Barbour County, Alabama, the loan limit is $184,600, while in Kauai County, Hawaii, the loan limit is set at $570,400.
- Live in a USDA-approved location
Typically, if a property is attached to a city ZIP code, it won’t qualify, but suburban areas outside of a major metro could. The USDA’s property eligibility map provides the most complete information about eligible and ineligible areas for guaranteed and direct loans backed by the USDA.
Most people are surprised to find out what counts as rural. For example, Readington, New Jersey, is designated as an eligible rural area, and that’s only about an hour outside New York City.
- Condition of home
Homes purchased with USDA funds must be up-to-date regarding health and safety functions. The federal goal of the Single Family Housing Guaranteed Loan Program is “to provide low- and moderate-income persons who will live in rural areas with an opportunity to own decent, safe and sanitary dwellings and related facilities.” You won't be able to take out a USDA loan for a property that isn’t deemed “decent, safe and sanitary” by USDA standards.
The USDA requires that you live in the home you secure the loan for. This prevents people from taking out a USDA loan to invest in a property they won’t actually live in. The USDA also disqualifies working farms as eligible for loan programs.
- Ability to make monthly payments
When evaluating your creditworthiness, lenders will also consider job history, income and assets. You must be able to demonstrate that your monthly mortgage payment won’t exceed 29 percent of your monthly income. Most lenders will want to see proof a steady income and employment for at least 24 months. You will not qualify for a USDA loan if you’ve been suspended from another federal program.
USDA loan pros and cons
Paying $0 down on a house with a long fixed-rate term sounds ideal for almost anyone. But there are some drawbacks to consider as well, particularly relating to eligibility requirements and processing lengths.
USDA loan benefits
- $0 down payment
USDA offers the only type of mortgage program that lets you roll closing costs into the loan, which is why it’s possible to finance 100 percent of the home purchase, including upfront fees and private mortgage insurance (PMI).
- Low fixed-rate interest rates
When you get a fixed-rate term, you don’t have to worry about your rates increasing over time. All USDA loans are available over 15- or 30-year terms. As with other types of loans, opting for a shorter term period will make your monthly payments higher while a longer term will spread payments out over more time, resulting in a lower monthly bill.
- Cheaper mortgage insurance
Most home loans require mortgage insurance to be paid monthly. Annual mortgage insurance premiums for USDA loans average only 0.30 percent, which is the lowest of any mortgage loan program (except for VA, which does not require mortgage insurance at all). Compared to FHA loans, mortgage insurance premiums are about $100 less per month for USDA loans.
- Flexible credit standards
Since USDA loans were created for people who can’t qualify for more traditional mortgage loans, lenders are more likely to accept applicants with spotty credit histories. Borrowers may be able to present alternative tradelines, such as cell phone bills, to represent their payment histories.
- No early payoff or prepayment penalty
The USDA won’t penalize you if you make larger payments. If you’re able to, paying off a USDA loan early could be worth it. You’ll pay less interest on the loan over time, gain equity in the house more quickly and see a better return on your investment.
USDA loan disadvantages
- Strict eligibility and qualification requirements
Eligibility requirements are factors like the location of the property you want to buy and income limits for that area. Qualifying requirements have to do with your credit history, debt-to-income ratio and ability to repay.
- Restrictive access
Even when you’re approved for a USDA loan, you can only use those funds to purchase a home in designated “rural” areas. Sometimes real estate agents don’t have a firm grasp on these boundaries, so you risk wasting your time touring homes and placing bids only to realize the property is a few blocks away from an eligible rural area.
- Longer approval process
It takes longer to get approved for a USDA loan than an FHA or conventional loan. A home seller might decide to sell their house to a buyer who doesn’t have to wait a long time to get the final stamp of approval.
The USDA loan application and approval processes are also more dependent upon the federal government than other conventional loans. For instance, during a government shutdown many prospective homebuyers who want USDA loans are left waiting in the wings until the government gets back to work.
USDA loan questions
Can you refinance a USDA loan?
Any USDA loan can be refinanced to a conventional (non-government) loan, but the USDA will only refinance mortgages that are already USDA loans. Refinancing a USDA loan will usually reduce your interest rate by at least 1 percent, and it’s pretty simple to do as long as you’re current on your agreed mortgage payments. You can refinance either a USDA guaranteed loan or direct loan through one of the USDA’s three types of refinancing programs:
- Streamlined refinancing
To be eligible for streamlined refinancing, you must have been in the home for at least a year and be current on your payments for 180 days before requesting the refinance. There are also debt-to-income ratio and credit requirements to be eligible for a USDA streamlined refinance. The total loan amount equals the current loan balance and interest, plus an upfront guarantee fee.
- Streamlined-assist refinancing
The most common way to refinance a USDA loan is with a streamlined-assist loan. You can refinance a USDA mortgage with a streamlined-assist loan even if it’s underwater, meaning that you owe more on it than your home is currently worth. Streamlined assist refinancing requires the mortgage has been paid as agreed for a full year before you submit a refinance loan application. There are no appraisal, credit check, equity or income qualification requirements to be eligible.
- Non-streamlined refinancing
A non-streamlined refinance is similar to a streamlined refinance but requires a new appraisal on the home. The total loan amount equals the home’s current appraised value. A new appraisal will be required to calculate the current market value.
What is the interest rate on a USDA home loan?
Interest rates for USDA direct loans are set at 3.25 percent. USDA-approved mortgage lender companies determine the interest rates for guaranteed loans based on current market conditions and an individual applicant’s credit history, among other factors. However, because of the government guarantee on these loans, interest rates are lower than the average interest rates for conventional loans, which is around 4 percent.
What is considered a rural area?
The USDA defines “rural” by exclusion, meaning that any area that does meet the criteria to be classified as “metro/urban” is, by default, classified as “nonmetro/rural.” According to the U.S. Department of Agriculture Economic Research Services Classifications, rural or nonmetro counties aren’t part of a larger labor market area and typically have open countryside and populations fewer than 2,500, though USDA loans are available in areas with higher populations. The map below illustrates how the borders of metro areas can extend beyond an urban center. Here, a “rural” area is any area that is not blue or green.
Can I buy a manufactured home with a USDA loan?
A USDA loan could pay for a new manufactured home, the purchase of the lot site and costs associated with transporting the home. The catch is that your manufactured home must have a permanent foundation to the property to be eligible, and it will be taxed as real estate. Otherwise, a manufactured home counts as “personal property,” and you won’t be able to use a USDA loan. Like any other property, a manufactured home must also be within an eligible rural or suburban area.
There are further restrictions on financing an existing manufactured home. You can only use a USDA loan to finance an existing manufactured home if it is already permanently installed. Put another way, a USDA loan can’t be used to move an existing manufactured home to a new site. The unit must have at least 400 square feet of floor space. Both the home and the site must also adhere to HUD standards, plus local and state government codes. You also can’t use the loan to buy furniture (e.g. beds and tables) but you can use the loan to buy utilities (e.g. heating or cooling equipment).
Bottom line: Are USDA loans worth it?
If you’re a prospective homebuyer earning less than a moderate income in a rural area, then a USDA loan could be a great option for you. If you meet USDA loan requirements, you’ll pay very little or $0 down on a house and get access to low fixed-interest rates over a 15- or 30-year term.
Remember, applying for a USDA loan is a lot like applying for any other mortgage loan. You must prove your creditworthiness, plus meet the USDA’s other qualifying requirements: your income must be significantly less than the median income in your area, and the property you finance with a USDA loan must meet certain criteria. The only way to confirm you meet the income and property requirements for a loan guarantee or direct loan from the USDA to consult the USDA Income and Property Eligibility site. If you are eligible for a USDA loan program, the site will direct you toward the correct application process.
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