USDA Direct Loan and Guaranteed Home Loan: Which is Better?

Family sittin in front of their new homeDeciding whether to take out a USDA Direct loan or a USDA Guaranteed Loan can be tricky. Both programs have their unique benefits and drawbacks that must be considered before making a decision. In this article, we will outline the key differences between the two kinds of loans so that you can make an informed decision about which one is best for you.

What Is the Difference Between a USDA Direct and Guaranteed Loan

When it comes to financing a rural home, there are two types of USDA loans that you can choose from, the USDA Guaranteed loan and USDA Direct loan. Both programs are designed to help low and moderate-income families purchase homes in rural areas, but there are some key differences between the two loan types.

USDA Guaranteed Loans

USDA Guaranteed loans are backed by the federal government and offered through participating lenders, such as banks, credit unions, and mortgage companies. These loans are similar to other government-backed loans, such as FHA and VA loans, in that they offer more flexible credit requirements and lower down payment options. However, USDA-Guaranteed loans also have unique benefits, such as no minimum credit score requirements and the ability to finance up to 102% of the home's value.

USDA Direct loans

Modest cape cod houseUSDA Direct loans are made directly by the USDA and have more stringent eligibility requirements. To qualify for a USDA Direct loan, you must have low (50% to 80% area median income) or very low income (less than 50% of the area median income) and be unable to obtain financing from any other source. These loans also have more favorable terms than USDA-Guaranteed loans, with lower interest rates and longer repayment periods. However, they may be a good option for borrowers who cannot qualify for the guarantee program.

What Is a USDA Guaranteed Loan?

The United States Department of Agriculture (USDA) offers a Guaranteed Loan program that is similar to the Direct loan program but with some key differences. Like the Direct loan program, the USDA Guaranteed Loan program provides financing for qualified applicants to purchase homes in eligible rural areas. The USDA Guaranteed Loan program does not require a down payment for borrowers whose assets are less than $50,000. The interest rate is higher with the Guarantee program. 

Another key difference between the two programs is that the USDA Guaranteed Loan program is offered through private lenders, while the Direct loan program is offered directly through the USDA.

These loans are available to moderate-income households who may not have access to credit from other sources. Guaranteed loans offer a 30-year term and fixed interest rate, so you’ll know exactly how much your monthly payment will be.

If you are interested in purchasing a home in a rural area and want to take advantage of the low-interest rates and no down payment options available through the USDA Guaranteed Loan program, contact a participating lender below.

What Is a USDA Direct Loan?

Both loan programs have different benefits, so it’s important to understand the difference before you decide which one is right for you.

USDA Direct loans are made directly by the USDA to eligible borrowers. These loans are for low and very low-income households who are unable to obtain financing from other sources. One benefit of Direct loans is that they offer flexible repayment options, including income-based repayment plans.

If you’re considering a USDA loan, it’s important to compare the benefits of both Direct loans and Guaranteed loans before you make a decision.

Difference Between USDA Guaranteed Loan and USDA Direct loan

When it comes to securing a loan from the U.S. Department of Agriculture (USDA), there are two main options: Guaranteed loans and Direct loans. So, what’s the difference between the two?

With a USDA Guaranteed loan, the USDA partially reimburses the lender if the borrower defaults on the loan. This guarantee allows lenders to offer borrowers lower interest rates and more favorable terms.

Direct loans are made directly to the USDA, and they typically have a longer pay off period than Guaranteed loans. However, they may be a good option for borrowers who cannot qualify for a Guaranteed loan.

So, which type of USDA loan is right for you? The answer depends on your circumstances and monthly income. If you have good credit and can qualify for a Guaranteed loan, that may be the best option. But if you have poor credit or cannot qualify for a Guaranteed loan, a Direct loan may be your only choice.

Closing Costs for a USDA Loan

The typical closing costs include title insurance, settlement fees, and lender fees are the same with both USDA programs. Closing costs cannot be rolled into the loan amount for purchase mortgages. Closing costs range between 2% to 4% of the sales price.

What Is a Guarantee Fee on a USDA Loan?

The guarantee fee is a cost charged to the borrower to support the USDA loan program. The fee is 1% of the loan amount ($100,000 X 1% = $1,000). The guarantee fee can be paid in cash or financed into the loan or paid by the home seller.

In addition to the upfront guarantee fee is the monthly mortgage insurance. The cost is calculated once a year and added to the monthly mortgage payment. The upfront guarantee fee is considerably less than the FHA upfront funding fee. The FHA charges 2.25% of the loan amount. The monthly FHA fee is .85% of the loan amount with a minimum down payment. The USDA monthly fee is .35%. The USDA fees are much less with the USDA program.

Now here's the good news for Direct loan borrowers. The USDA does not require the upfront fee or monthly fee for Direct loans.

USDA Debt to Income Ratio

Lenders and the USDA use a simple formula to determine the ideal mortgage payment and maximum monthly debt. The USDA looks for a mortgage payment of 33% of the borrower's monthly gross income. The payment calculation includes the real estate taxes and homeowner's insurance.

Mortgage insurance is not included in the payment ratio for Direct loan borrowers. The payment ratio is often called the front-end ratio.

The borrower's monthly debt and new mortgage payment should be at or below 41% of the borrower's gross monthly income. The debt ratio is known as the back-end ratio.

Since the USDA acts as the lender for Direct loan borrowers, the USDA will discount the interest rate and possibly extend the loan term to 38 years to help the borrower get into a home. The interest rate can be pushed down to 1% to help worthy borrowers.

Interest rate subsidy is only available with Direct loans.

USDA Income Limits

Income tax graphicThere are income limits with the USDA Guaranteed and Direct loan programs. Borrowers must have an adjusted gross income (AGI) of less than 115% of the median income for their area. However, there are some exceptions to this rule.

For example, if you are purchasing a home in a rural area, you may be eligible for a USDA Guaranteed Loan even if your AGI is more than 115% of the median income for your area.

To see if you are eligible for a USDA Guaranteed Loan, you can check the USDA Income Eligibility site.

The base household income for the Guarantee loan program is:

1-4 member households increased to $103,500
5-8 member households increased to $136,600

The income limit for the Direct loan program is much less than the Guaranteed program. Use the lookup tool to determine your household income. You'll notice that there are two options.

USDA lookup graphic

USDA Loan Terms

Direct loans have a term of 33 years and up to 38 years for eligible home buyers. A longer payoff reduces the monthly mortgage payment. The interest rate is fixed for the Direct loan.

Guaranteed loans are made by private lenders, but they are guaranteed by the USDA. This means that if you default on your loan, the USDA will pay back the lender. Guaranteed loans only offer 30-year terms and have higher interest rates than the Direct program.


 Credit Requirements for a USDA Loan    

Credit history graphicThere are no credit score requirements with the USDA home loans. But, the USDA recommends a credit score of at least 640 for the Guarantee loan. The lender decides the minimum credit score. Some lenders will go as low as 580.

For Direct loans, the USDA desires a 640 credit score or higher, however, if the applicant has a credit score less than 640, the USDA will focus on the borrower's creditworthiness and desire to satisfy debt commitments.

For example, a borrower who has open collection accounts without a good explanation (i.e. medical, job loss) may be declined for a mortgage.  Credit requirements for the Direct loan are more flexible than for a Guarantee loan.

USDA Eligible Property Types

Finding a suitable property is a crucial step in the application process for both USDA guaranteed and Direct loans. The property must be structurally sound, functioning, and in good condition. Additionally, it must be located in a suitable rural area.

The extra condition for USDA Direct loans is that the house must be smaller than 2,000 square feet. Before the loan is completed, the property must undergo a home inspection to confirm it fits the USDA requirements.

For Guarantee loans, single-family homes, manufactured homes (doublewides 2006 or newer with permanent foundation), approved condos, and modular homes are acceptable to the USDA. New construction, manufactured homes (AKA mobile homes), and modular homes must be deeded as real estate and taxed as such.

Benefits Of a USDA Guaranteed Loan

There are many benefits to USDA-Guaranteed loans, including no down payment, low-interest rates, and flexible credit guidelines. Guaranteed loans are available for both purchase and refinance transactions.

No Down Payment: One of the biggest advantages of a USDA loan is that there is no down payment required. This makes homeownership possible for buyers who may not have the savings for a typical down payment.

Low-Interest Rates: Interest rates on USDA-Guaranteed loans are typically lower than conventional mortgage rates. This makes monthly payments more affordable and helps families keep more of their hard-earned money.

Flexible Credit Guidelines: USDA guidelines for credit scores are typically more flexible than those for conventional loans. This means that more people will qualify for this type of financing.

Benefits Of a USDA Direct loan

The USDA Direct loan program offers many benefits to borrowers looking for financing to purchase a home in a rural area. Here are some of the key benefits of this loan program:

  1. No down payment is required.
  2. 33 year term (and possibly 38 years)
  3. The interest rate will remain the same during the duration of the loan.
  4. No monthly mortgage insurance.
  5. There is no prepayment penalty if you pay off your loan early.
  6. You can finance up to 102% of the purchase price of the home, which can help with closing costs.
  7. No upfront guarantee fee.
  8. Discounted interest rate for eligible borrowers.

These are just a few of the reasons why the USDA Direct loan program can be a great option for those looking to buy a home in a rural area. If you think this loan program could be right for you, contact a participating lender today to get started on the application process.

What Are the Disadvantages of a USDA Loan?

There are a few disadvantages to the Direct and Guaranteed programs:

  1. There are income limits for both programs.
  2. The home must be located in a USDA-eligible area.
  3. The debt to income ratio (back-end ratio) is lower than the FHA loan for both loans.
  4. No mortgage insurance is required for the Direct loan, but the borrower's income must be low or very low for the Direct loan program. The Guarantee program requires mortgage insurance and it never goes away, regardless of the down payment (if any) or accumulated equity. The income limits are higher with the Guarantee program.
  5. The loan term for a Guaranteed loan is 30 years only. The loan term for the Direct program is 33 years and possibly 38 years for very low-income borrowers.
  6. The interest rate for the Direct program is established monthly and is lower than the interest rate on the Guaranteed loan.

How Do I Apply for a USDA Loan?

Mortgage applicationTo apply for a USDA guaranteed or Direct loan, you must first contact an approved lender. You can find a list of approved lenders below. Once you have found an approved lender, you will need to complete an application and provide the required documentation.

The next step is for the lender to determine if you are eligible for the loan. If you are, the lender will then send your loan application to the USDA for approval. The USDA will then issue a guarantee or make a direct payment to the lender.

It is important to remember that you are not guaranteed to receive a loan just because you meet the eligibility requirements. The final decision will be made by the USDA based on their funding availability.

Here's a list of USDA offices

USDA Gift Funds

Gift fund boxNo down payment is required for the Direct and Guaranteed programs, however, there are closing and escrow costs. Borrowers who lack the money to cover the settlement costs are permitted to use gift money to pay these expenses. There are strict requirements for gift funds, so speak to your loan officer before accepting a check from a donor.

USDA Seller Concessions

The USDA permits a sales concession from the seller. The maximum seller concession is 6% of the sales price. The sales concession must be disclosed in the sales contract. Sales concessions are typically used to pay closing and escrow costs.

Rotating question markUSDA Loans FAQ

What is a guaranteed loan?
A guaranteed loan is a mortgage that is backed by the federal government. The government guarantees that the lender will not lose money if the borrower defaults on the loan.

Who can apply for a guaranteed loan?
Anyone who meets the eligibility requirements for a Direct loan from the USDA can also apply for a guaranteed loan.

What are the interest rates for a guaranteed loan?
Interest rates for Guaranteed loans are set by the lender and may be higher than rates on other types of loans. The USDA sets the interest rates monthly for the Direct program.

How long do I have to repay a guaranteed loan?
The repayment period for a guaranteed loan is 30 years. The Direct loan term is usually 33 years, however, for some low-income home buyers, the term is 38 years.

Do USDA loans cover closing costs?
The USDA does not cover closing costs. However, a willing seller is allowed to pay up to 6% of the sales price toward the closing and escrow costs.

Who pays closing costs on a USDA loan?
Closing costs are the responsibility of the home buyer.

Can the seller pay the USDA guarantee fee?
Borrower money, seller concessions, gift funds, grant funds, lender contributions, and upfront guarantee fee payments are all acceptable methods of payment.

Read more about USDA loans with our questions and answers page

Conclusion

There are a few key things to remember when considering USDA guaranteed vs. Direct loans.

First, with a Guaranteed loan, you will need to have good credit to qualify.

Second, with a Direct loan, you can get up to 100% financing for your home.

Third, with a Guaranteed loan, you will have to pay PMI (private mortgage insurance) if you put less than 20% down on your home.

Lastly, with a Direct loan, there is no PMI required. When deciding which type of USDA loan is right for you, be sure to consider all of these factors so that you can make the best decision possible.