Sweet Homes

Requirements For USDA Loans

USDA loans are subsidized by the U.S. government, and more specifically, are backed by the U.S. Department of Agriculture. In other words, the USDA takes on the responsibility of paying the lender back if you default on your mortgage.

Since the USDA is taking on a lot of the risk, your lender can offer you a lower interest rate. Ultimately, government-backed loans make it affordable for lower-income households to buy a home.

USDA Loan Eligibility

To qualify for a USDA loan, the home must be in an eligible rural area and you must meet specific income requirements. Keep in mind that USDA construction loan requirements differ from USDA loans. Let’s look at those requirements, as well as the credit score, debt-to-income ratio and down payment requirements.

Rural Area Requirements

To get a USDA loan, the home you’re buying or refinancing must be located in an eligible rural area; you can check the eligibility of the address on the USDA website. If you look at the property eligibility map, you’ll notice that the USDA’s definition of “rural area” is very broad. Many homes in suburban areas qualify as “rural” based on the USDA’s definition.

Income Requirements

USDA loans are one of the only types of mortgages that specify income limits. These income limits depend on the location of the home you’d like to buy and the number of people in your household. Under the guidelines, you’re ineligible for a USDA loan if your household income exceeds 115% of the median income for your area. This requirement includes all adults that live in the house – not just the adults listed on the mortgage.

Credit Score

To be eligible for a USDA loan, you must have a credit score of at least 640 for automated approval. With a credit score of 600 – 640, you will have to go through manual underwriting where an underwriter will comb through your records.

Debt-To-Income Ratio

When lenders assess your ability to pay back your loan, they also look at your debt-to-income ratio (DTI). Your DTI represents the amount of your monthly income that goes toward paying off recurring debt. It’s best to keep your DTI at 50% or below if you want to qualify for a USDA loan.

Down Payment Requirements

USDA loans don’t require a down payment. Because the government backs USDA loans, lenders can issue them with no money down. This can be a huge advantage if you lack the money for a down payment. However, keep in mind that you’ll still need to pay closing costs.

Comparing USDA Vs. Conventional Loans

There are some key differences between USDA and conventional loans. Let’s look at the major differences so you can decide which loan type is right for you.

Location

Conventional loans are available nationwide. USDA loans, on the other hand, are only available in eligible rural areas as determined by the USDA. If you’re located in a major metropolitan area, you likely won’t be able to get a USDA loan. Just keep in mind that the USDA’s definition of rural areas includes many suburbs as well.

Residence Type

USDA funding can only be used on your primary residence, but conventional loans don’t have these same restrictions. You can get a conventional loan for a number of reasons, including buying or refinancing your primary residence, secondary residence or investment property.

Income Limits

There are limits on how much you can make in order to qualify for a USDA loan. Your household income can’t exceed 115% of the area’s median income. All members of the household will need to have their income considered by the lender.

If you’re trying to qualify for a conventional loan, on the other hand, there are no income limits.

Private Mortgage Insurance And Guarantee Fees

Conventional loans require private mortgage insurance (PMI) from borrowers who put less than 20% down. This fee is based on your loan-to-value ratio (LTV) and your credit score. It generally ranges from about .1% – 2% of the unpaid loan amount. Borrowers with lower credit scores and higher LTVs (i.e., lower down payments) generally have to pay more for PMI.

USDA loans, on the other hand, require you to pay a guarantee, or funding fee. This fee is paid both at closing and monthly. The upfront fee, paid at closing, is 1% of the loan amount. Then, each year, you’ll pay .35% of the scheduled unpaid principal balance of the mortgage. This annual fee is split over 12 months and paid as part of your monthly payment.

Whether private mortgage insurance or the USDA guarantee fee is cheaper for you all depends on your personal situation. If you have a lower credit score or down payment, the guarantee fee may be cheaper than the cost of PMI.

Appraisals

An appraisal is an unbiased estimate of the fair market value of a home. The appraisal is a vital step to ensure that you don’t overpay for your home. Both USDA and conventional mortgages require an appraisal.

During the appraisal inspection, the appraiser will look for any major problems with the home. Properties financed with a USDA loan (or other government-backed loan) will generally have to meet stricter requirements than properties financed with a conventional loan. If you’re buying a fixer-upper, a conventional loan may be a better bet.

Available Interest Rates

Outside of the down payment, one of the biggest appeals of a USDA loan is that it’s offered at a low interest rate. In many cases, interest rates for USDA loans are lower than rates for conventional loans. The government backing of USDA loans typically means that lenders can issue them with competitive interest rates.

Approval Process

Getting an approval for a USDA loan might take slightly longer than getting an approval for a conventional loan. Since the USDA loan needs to be approved by both the lender and the USDA, the entire process, from application to closing, can take approximately 30 – 60 days.