A Quick Guide To USDA Loan Benefits
USDA loan benefits compare well with other mortgage options, especially for those who want to buy or refinance in rural areas. There are not a lot of financing choices out there that feature the combination of nothing down, no prepayment penalties, flexible qualification standards, low guarantee costs, and attractive rates. Here are the important points you need to know, both pros and cons.
We usually think of the US in terms of its major metro areas, the 200 or so cities where much of our population lives. At the same time, we are largely a rural nation. According to the USDA, rural America includes 74% of our land and 46 million people – about 14% of our total population.
The federal government has several programs to help buyers purchase or refinance their homes, including:
There are several types of USDA loan financing.
Direct USDA mortgages are for low-income individuals with significant housing needs. According to the USDA, applicants must:
Guaranteed USDA mortgages are specifically designed for borrowers who want to finance rural property. Such financing is open to borrowers who:
You can learn more about the USDA loan program here, or see the eligibility requirements for a USDA loan here.
Why would you choose a USDA loan over other financial options? Several reasons stand out.
Pulling together a large down payment is a major financial hurdle for many households. With USDA financing, there’s no down payment requirement. This is possible because lenders know that if a problem with the loan arises, the federal government will offset the debt.
| Loan Type | Minimum Down Payment Required |
|---|---|
| USDA | 0 |
| FHA | 3.5% |
| VA | 0 |
| Conventional | Typically 5- 20% |
Because the government guarantees USDA loans, lenders face less risk. Lenders may be willing to offer financing with lower interest rates. Actual interest rates will vary, depending on such factors as the borrower’s credit standing, monthly debt expenses, and market conditions.
Borrowers who use FHA, VA, and USDA loans can obtain financing with little or nothing down. This is possible because Uncle Sam promises to help lenders in the event repayment difficulties arise. With a strong third party in the picture, lenders will finance with little or nothing down.
The USDA guarantee program works this way. You borrow $200,000 at 6.5% and Uncle Sam guarantees that 90% of the loan will be repaid to the lender. The lender – who supplies the cash for the financing – provides the entire $200,000 to the borrower. Borrowers pay for Uncle Sam’s backing with two fees:
First, a 1% Upfront Guarantee Fee. This fee can be paid at closing, but many borrowers elect to have it added to the loan amount to reduce cash needs.
Second, a .35% Annual Fee. The Annual Fee is paid in monthly installments.
Here's how a $200,000 mortgage at 6.5% compares with other loan options.
| Loan Type | PMI Features | Program Rates | Estimated Costs |
|---|---|---|---|
| USDA | Borrowers pay annual fee for the life of the loan. | 1% Upfront Funding Fee 0.35% Annual Fee |
$2,000 Upfront $58 per Month |
| FHA | Borrowers pay annual fee for the life of the loan. | 1.75% Upfront Funding Fee 0.85% Annual Fee |
$3,500 Upfront $139 per Month |
| VA | Fee varies based on nature of service, down payment and first-time use. | 2.15% Funding Fee for Most Purchase Loans | $4,300 Upfront |
| Conventional | Rate varies based on credit score and down payment amount. | 0.2 - 1.5% PMI | $1,000 - $2,000 Annually |
For conventional loans, PMI typically ends once the borrower's loan-to-value ratio reaches about 80 percent.
Borrowers with FHA and VA loans can lower their mortgage insurance costs by putting down at least 5 percent.
Most conventional lenders look for a credit score of at least 640; however, you’ll need a higher score to qualify for the lowest interest rates, perhaps 740, 760, or 780. Luckily, there is no official credit score to get a USDA loan.
Lenders typically want a 640 score or better because that means the loan application can be processed with the USDA's Guaranteed Underwriting System (GUS). Borrowers with lower credit scores can still qualify for USDA loans when the loan is manually underwritten.
The vast majority of the United States falls within what the USDA considers an eligible, rural area. The USDA has various ways to define “rural” property, and some homes are located close to major metro areas.
Learn more about other property requirements for USDA loans here.
USDA loans are available with fixed rates in 15- and 30-year terms. Adjustable-rate loans and hybrid financing are not supported.
The USDA program does not work for everyone. Like all mortgages, it has conditions and limits that make it attractive to some borrowers but not to others. Here are three likely situations where USDA financing will not work for certain borrowers.
USDA loans are designed to promote homeownership in rural areas. Therefore, properties must be located in eligible rural or suburban regions as defined by the USDA. This means homes in densely populated urban centers typically do not qualify.
To ensure assistance reaches low- to moderate-income families, USDA loans impose income limits based on household size and geographic location. Applicants exceeding these income thresholds may not be eligible for the program.
USDA loans are intended for owner-occupied primary residences. As such, they cannot be used to finance investment properties, vacation homes, or rental units. Borrowers must certify that the property will be their primary place of residence.
While USDA loans do not require private mortgage insurance (PMI), they do include an upfront guarantee fee and an annual fee. These fees contribute to the overall cost of the loan and are similar to mortgage insurance premiums required by other loan programs.
USDA loans have specific property requirements to ensure homes are safe and livable. Certain types of properties, such as income-producing farms or homes with significant acreage beyond a typical residential lot, may not qualify. Additionally, the property must meet USDA standards, which could necessitate repairs or improvements before approval.
Understanding these considerations can help you determine whether a USDA loan is the right fit for your home financing needs.
It can be useful to compare the basic costs for various types of mortgage financing. Here’s a look at USDA Guaranteed loans and several other mortgage options if we need $200,000 in financing at 6.5% interest. When looking at loan comparisons, be aware that not all costs and factors are included. For instance, VA mortgage financing is only available to those with qualifying federal service. Also, in addition to loan down payments, borrowers are likely to pay closing costs for such expenses as title insurance, transfer taxes, and settlement services.
| Loan Type | Minimum Credit Score | Minimum Down Payment | Funding Fee* | Principal & Interest | Taxes & Insurance | Mortgage Insurance* | Monthly Payment |
|---|---|---|---|---|---|---|---|
| USDA | 640 | $0 | $1,500 | $790 | $250 | $44 | $1,084 |
| FHA | 640 | $5,250 | $2,625 | $769 | $250 | $106 | $1,125 |
| VA | 640 | $0 | $3,225 | $799 | $250 | $0 | $1,049 |
| Conventional | 640 | $7,500 | $0 | $743 | $250 | $90 | $1,083 |
*Note: Funding Fee and Private Mortgage Insurance amounts for each loan type are based on standard associated government guarantee fees.
As you can see, the two zero-down options have the lowest monthly payment given these parameters. But remember the second benefit from above; USDA loans typically offer some of the lowest interest rates on the market – meaning your specific situation could yield even more savings, depending on other compensating factors.
Credit score minimums will vary based on the lender, loan type and other factors. While FHA, USDA and VA loans allow for credit scores below the listed minimums, most lenders require at least a 640 score for any government-backed mortgage.
Interested homeowners can contact a home loan specialist to see if they are eligible.
