One of the signature policy ideas of the 20th century was home ownership. Through bank reform, lending practices, taxes and other policy channels, the U.S. government set itself to the task of ensuring that Americans who wanted a home could buy a home.
The USDA loan program is part of that push.
What Is a USDA Loan?
Otherwise known as a Rural Development Mortgage, USDA loans are a government-backed mortgage program that sponsors zero down payment mortgages for people who have limited credit. The loans are specifically for rural and some suburban residents, with the aim of helping to develop America's small towns.
The Department of Agriculture offers these loans at interest rates below the average mortgage. Although offered through the USDA, this program is not directed at farmers. It is a low-income housing program designed to help non-urban consumers buy houses who otherwise might not qualify for a loan or afford a mortgage. As a result the requirements to qualify for a USDA loan tend to be different, and typically less stringent, than for a traditional bank loan.
Types of USDA Loans
There are three types of USDA housing loans:
These loans are issued directly by the Department of Agriculture. This makes them similar to the housing loans offered by the Department of Defense and Veterans Affairs. While direct loans typically offer the best interest rates, sometimes below 1% depending on the applicant and area, they are also highly income-restricted. This program is geared toward low- and very low-income households. You cannot get a direct loan without demonstrating that you can't afford any other available terms.
This is sometimes otherwise known as a Section 502 Loan, referring to the code section which created the program.
These loans are issued by banks and other private lenders but backed by the Department of Agriculture. (This means that the USDA will pay the lender back in the event that you default on the mortgage.) As a result, lenders will issue mortgages to people with lower credit scores than they would otherwise and will do so on more favorable terms.
Like a direct loan, the guaranteed loan program has income requirements. It is less stringent than direct lending, however. This program targets low income households.
In both cases the government's involvement means that borrowers pay little, if anything, in the form of a down payment.
In addition to its mortgage program the Department of Agriculture also issues loans and grants to rural residents for home upgrades and repair. As with the direct lending program, the USDA provides these grants to low- and very low-income households. The homeowner must use them to "repair, improve or modernize" the home or "remove health and safety hazards" and must occupy the house; in other words, you cannot get a USDA grant to improve a rental property.
The USDA provides a fact sheet explaining in greater detail what a repair loan is and how to get one.
How Does a USDA Loan Work?
The USDA loan program works by either extending credit directly or by insuring up to 90% of a mortgage issued by a private lender. As a result, the agency can shape the terms of these loans, which are focused on helping rural people who otherwise couldn't afford to buy a home.
The USDA issues loans for people who want to buy a home as their primary residence. (Business owners who want to develop rental housing can apply for subsidies through the USDA's Section 515 program, which helps to expand the rental stock in rural communities.) The home must be in a qualifying rural area, and in addition to the purchase price the loan typically covers mortgage insurance assistance, closing costs and other necessities.
Borrowers can use a USDA loan to purchase, upgrade or expand a qualifying home. Some of the specifically approved uses include:
• Repairs and rehabilitation when associated with the purchase of an existing dwelling.
• Refinancing of eligible loans.
• A pro rata share of real estate taxes that is due and payable on the property at the time of loan closing. Funds can be allowed for the establishment of escrow accounts for real estate taxes and/or hazard and flood insurance premiums.
• Essential household equipment such as wall-to-wall carpeting, ovens, ranges, refrigerators, washers, dryers, heating and cooling equipment as long as the equipment is conveyed with the dwelling.
Homeowners can check with the agency to find a full list of legitimate expenses, which can include property improvements as well as certain utilities and appliances.
Who Can Get a USDA Loan?
Applicants for a USDA loan must meet several criteria.
• You must fall within the program's income limits, typically 115% of the median income for your region or less. The direct loan program requires a considerably lower income threshold than the guaranteed loan program does. As with all federal programs, income thresholds vary by community, household size and household composition.
A good first step before applying is to enter your personal information to see if you qualify for a USDA loan's income limits.
• You must not use the loan for a commercial purpose. The borrower has to personally occupy the home.
• You must be a U.S. citizen, national or qualified alien and must be legally able to take on debt. (For example, minors and the mentally incapacitated cannot use this program.)
• You must purchase the home in a qualifying rural area. This program does not apply to cities, and the federal government runs no similar program to subsidize urban home ownership. You can search the USDA's map to find qualifying areas.
• You must demonstrate the ability to pay this mortgage. While the criteria for a USDA loan is considerably lighter than with a bank, the agency still requires certain financial metrics. The mortgage payments must typically be 30% or less of your demonstrated income, and you can't spend more than 40% of your income on other debt payments. You must also not have had an account recently enter collections.
Outstanding debts to the U.S. government, such as unpaid taxes, will almost always disqualify you.
• You must show your credit score. For a guaranteed loan most banks will require a credit score of at least 640, since this is the cutoff for the USDA's automatic approval underwriting process. However, this is not a minimum requirement and some banks may choose to proceed anyway.
The direct loan program also requires a score of at least 640 for automatic approval. Again, if you have a lower score or no credit history you may still qualify depending on specific circumstances and if you can show a history of on-time bill payment through paperwork such as rent and utilities.
USDA Direct Loan Specific Requirements
In addition to the above, the direct loan program adds the following requirements.
• You must not currently have "decent, safe and sanitary housing."
• You must have been unable to find a loan from other sources on terms that you could reasonably meet.
• You must buy a home that is 2,000 square feet or less with a market value no greater than the area's loan limit and (specifically) no in-ground swimming pool.
How to Apply for a USDA Loan
The best place to start is to make sure that you meet the program's geography and residency requirements, and you can start that search with the USDA's loan resources.
If the USDA loan program seems like a good fit, your next step is to contact an approved lender. The USDA keeps a list of Nationally Approved Lenders, although this is not a comprehensive list. As a result, you might want to also contact your local bank to see if they participate in the program. For people borrowing through the guaranteed program the borrowing process will then take place through the lending institution.
People who want to borrow through the direct loan program must first look at these private lenders as well, since you will need to demonstrate that you couldn't find a loan on acceptable terms. Then, you will apply through your nearest Rural Development office. The USDA keeps a list of all offices and their contact information. You can also find a drop-down menu that links to each state's contact Rural Development contact information, with a state-specific information sheet on the direct loan program, here.
For any questions you can reach out to one of the USDA's loan contacts placed around the country for interested borrowers.