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What are USDA Home Loans? Do I Qualify?

November 17, 2019

 

What are USDA Home Loans? Do I Qualify?

Deciding between rural and suburban is one of many choices you'll make along your homeownership journey. And if the countryside is your preference, then you may want to consider applying for a USDA loan. You've probably heard of the USDA loan program, as it's one of the more popular mortgage loans available. However, you may not know too much about the particulars, such as whether you qualify, what closing costs are like and which mortgage lenders offer them. 

You're about to learn more about all this so you can determine if this loan is right for you. 

 

A USDA-RD mortgage allows for a great deal of flexibility

 

What is a USDA-RD loan?
The USDA loan program is a mortgage offering backed by the United States Department of Agriculture. More formally known as a USDA-RD loan - the RD short for "Rural Development" - this mortgage product is geared toward families who plan on buying in a rural neighborhood. Rural home loans are designed to provide low- to moderate-income families with more of an opportunity to buy a home at an affordable price. Due in part to high demand and stretched inventory, home prices are on the rise in most locations. Indeed, according to the most recent estimates from the National Association of Realtors, the typical single-family residence in the U.S. costs around $280,800. As of July, existing-home prices have increased for 89 months in a row on a year-over-year basis.

Of course, a USDA loan doesn't reduce the cost of a property's listed price, but it can provide certain benefits that may make it a bit easier for borrowers to qualify. For example, you may be eligible for a lower down payment than you would be with a different mortgage product, perhaps even 0% down.

What are the main advantages of a USDA-RD loan?

Low or no down payment loans often get mischaracterized as mortgages that box borrowers in, leaving them with fewer options in terms of where they can buy their house or for what purposes. This certainly doesn't apply to USDA loans. They allow for a great deal of flexibility. For example, aside from buying a residence, you can also use this mortgage for refinancing or home improvement purposes. Additionally, you may be surprised by the loan amount for which you're eligible. This depends on the state you live in and how much you earn. USDA loans have fixed interest rates and are typically sold in 15-year and 30-year increments. 

Furthermore, closing costs can be arranged so that they're included in the financing or paid in full or in part by the seller. 

Another mischaracterization of rural loans is that since they only apply to rural locations, this prevents borrowers from considering houses that are in or near the city. However, what qualifies as "rural" applies to 97% of America's land area, according to the latest estimates from the U.S. Census Bureau. Translation: You likely have more options to buy outside the city than within.

Picture of a houseWhat's the difference between a USDA direct loan and USDA guaranteed loan?
As a first-time homebuyer, it's important to understand the distinctions between a USDA direct loan and USDA guaranteed loan. While they both are provided through the Department of Agriculture, they're geared toward slightly different audiences. For example, the USDA guaranteed loan is typically taken out by borrowers who earn a moderate income, while the direct loan is designed for families who make substantially less per year than what's typical in their area, or low to very low. What qualifies as "low income," "moderate" and "very low" varies, but generally speaking, low income is 50% or less of the median salary in a given area while moderate is between 50% and 80%.

Another way USDA direct and USDA guaranteed loans differ from one another is who backs or finances them. For the former, it's the USDA directly, but for the latter, private lenders provide the funding.

As you might imagine, the qualifications necessary to be approved for a USDA direct loan versus a USDA guaranteed loan are also a bit dissimilar. Take credit history. For the direct home loan program, applicants need a "reliable" FICO® score of at least 640 ("reliable" in this context means three or more trade lines in the previous two years). For the guaranteed home loan program, the "validated" credit score minimum is 640 ("validated" is defined by USDA as two or more trade lines opened in the previous year or more).   

Which one is best for you? That's something your lender can help you determine based on your needs and financial circumstances. 

Couple sitting with a loan officer

Who qualifies for a USDA loan? 
As with most things in real estate, determining whether you qualify for a USDA is a case-by-case basis. Several factors are taken into consideration. For example, the property you plan on buying must be used as a primary residence - as opposed to a vacation home - fall within an "eligible rural area" as determined by the USDA, and the owner must meet certain income requirements. It's this last factor that has several parts to it:

Location
As the old saying goes, real estate is all about location, location, location. Area influences the style of house you're likely to see and the amount of money you can expect to spend. Not only do prices in regions of the country vary considerably, USDA loans are only available for properties with rural zip codes. Because populations are always changing, what may be considered a rural area today may be different a year or two from now. This makes it difficult to determine with precision whether the property you want is in a rural part of the U.S. Once again, your lender will be able to provide the certainty you need. 

Debt to income
DTI refers to how much of your monthly earning goes toward paying expenses. The lower the percentage, the more money you have to use at your discretion. Generally speaking borrowers should have a DTI ratio no higher than 41%. There may be exceptions to this, which your mortgage lender may point out depending on your financial situation.

  

Credit history
Your credit reflects how consistent you are with making payments in a timely fashion. It's determined through your credit or FICO® score. Factors that influence your score include the amounts you owe, new credit, payment history and types of credit. USDA loans typically require a FICO® score of at least 640. Much like your DTI, your lender may have a different standard and, the credit score you need may also depend on whether you're applying for a USDA guaranteed loan or a USDA direct loan. We'll discuss this further a bit later. 

Income
You'd be hard-pressed to find two borrowers with identical incomes. Similarly, the earnings of eligible USDA loan borrowers run the gamut. The minimum or maximum income amount depends in part on whether you're taking out a direct loan or a guaranteed housing loan. If it's the latter, you may be able to earn more than what the median household income is for your area and still be eligible (up to 115%). 

Mortgage insurance
Surveys show the down payment is one of the more common barriers Americans encounter when deciding to purchase real estate, particularly among first-time buyers. Perhaps the most attractive aspect of USDA loans is the fact that you may not need a down payment to be eligible. Taking advantage of this aspect may require you to purchase mortgage insurance, though, in case of default. What you can expect to spend on mortgage insurance depends on the other aspects of your financial situation in accordance with your lender's purchase or refinancing options. 

house in an hourglass

When will you get a decision about approval? 
Now that you know a little more about some of the qualifications associated with applying for a USDA rural development loan, you may be wondering about how long you can expect to wait before an approval decision. The journey to homeownership can be summed up in three words: It's a process. Lots of factors are analyzed and documents examined (e.g. paystubs, tax returns, proof of assets, employment information, etc.). Since each individual or family's situation is different, approval timeframes can vary. However, the average period is three weeks (this could be different for each state). Part of the reason for this is the multi-step aspect to authorization. In addition to your lender, the USDA also has to sign off on it before the decision becomes final, and prior to that, there needs to be an appraisal done on the property that you seek to buy. 

There are a few things you can do, however, to speed up the process. For example, do your best to have all the information your lender asks for when they need it. This may include two years' worth of W-2 forms, tax returns, your credit report (or Social Security number so your lender can run a check) and a street address for your employer. You may also want to include the phone number of the business you work for as well.

Woman doing paperwork

You should also strive to avoid any drastic expenditures while your application package is processing. Life is literally event-full, involving milestones, memories and major purchases. But while you're awaiting a decision, put any forthcoming changes on the back burner for the time being. For example, if you're looking to buy a new car or go on an all-inclusive vacation, save that for some other day, as large purchases such as these could raise a red flag.

Finally, be reachable. There are a lot of working parts to applying for a rural development loan, and things may come up that your lender may need to talk to you about. Getting back to your lender in a timely fashion ensures that the approval process doesn't take any longer than it needs to. 

If homeownership is your aim, a USDA home loan can help you reach the target. Please contact Residential Mortgage Services - we'll guide you home. 

 

Article provided courtesy of Tim Hidell, Residential Mortgage Services.

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