USDA Direct Loan Vs Guaranteed

Family sitting in front of their new home

Understanding the distinction between USDA-guaranteed and direct loans is crucial if you're exploring USDA loans for your home financing needs. The terms "USDA Direct vs. Guaranteed" refer to two distinct programs the United States Department of Agriculture offers.

The USDA Direct loan is designed for low-income applicants, offering subsidized interest rates and tailored payment plans. On the other hand, the USDA-Guaranteed loan is available to a broader range of income levels. It involves a partnership with approved private lenders, guaranteeing the lender against potential losses.

To navigate the options effectively, delving into the differences between USDA direct and guaranteed loans will empower you to make informed decisions based on your financial circumstances and homeownership goals.

What is a USDA Home Loan?

A USDA loan is a mortgage loan designed to encourage rural homeownership. It offers low-interest rates, reduced or eliminated down payment requirements, and flexible credit criteria for borrowers seeking financing in eligible rural areas. The U.S. Department of Agriculture (USDA) administers this government-backed program.

The main types of USDA loans are direct loans and guaranteed loans. A direct loan is funded directly through the USDA. In contrast, a guaranteed loan is issued by an approved lender but backed by the federal government through the USDA's Rural Development Guarantee Program.

Both types of loans have similar eligibility requirements, including income limits based on location, household size, and property in an eligible rural area. The primary difference between these loan options is their respective interest rate structures.

Direct loans offer lower fixed rates than most market-rate mortgages and potential subsidies for some qualified borrowers. In contrast, guaranteed loans feature adjustable rates that may start more deficient than those provided with direct loans but could increase over time due to changing market conditions.

USDA Direct Loan Program

The USDA Direct Loan Program, also known as the Section 502 Direct Loan Program, helps low-income individuals purchase decent, safe, and sanitary housing in qualifying rural areas. It provides payment assistance and enhances the applicant's loan repayment ability. Payment assistance functions as a subsidy, temporarily reducing the mortgage payment burden. The level of assistance provided is determined based on the applicant's adjusted family income.

Loan application is made directly through a USDA office.

Term

The Direct loan allows borrowers to apply directly to the USDA Rural Development Agency. This type of loan requires no down payment and provides a fixed-rate 33-year term. Very low-income home buyers may be offered a 38-year term. The benefit of the 33 and 38-year term is to lower the monthly mortgage payment.

USDA Direct Loan Credit Score

The USDA desires a 640 credit score for Direct Loans; however, Depending on the borrower's circumstances, this will not prevent a borrower from purchasing a home. The USDA takes a holistic approach to credit scores and the applicant's credit history.

USDA Direct Loan Income Limits

Applicants must meet the USDA income thresholds for their area. The USDA provides a self-assessment tool on its website to help determine whether you meet the income limit for a direct loan.

If you choose to use the self-assessment tool, take a minute to determine the income limit for your area.

Area Loan Limit

The area loan limit is the maximum loan and purchase price limit.

USDA Direct Loan Interest Rates

The USDA establishes the interest rate for the Direct loan, which is likely to be 2-3% less than the market rate. Very low-income home buyers may be eligible for a 1% interest rate.

Upfront Mortgage Insurance

The Direct loan does not require upfront mortgage insurance.

Private Mortgage Insurance

No PMI with the Direct Program.

Guaranteed Home Loan Program

The Section 502 Guaranteed Loan Program aids approved lenders in facilitating homeownership for low- and moderate-income households. It enables them to acquire suitable, modest, and safe dwellings in eligible rural areas to serve as their primary residence. Eligible applicants can purchase, build, renovate, enhance, or relocate a dwelling in a qualifying rural area with 100% financing.

Do not assume you are automatically approved for a loan through the USDA. While the guarantee applies to USDA lenders, it does not guarantee approval.

Term

The USDA only offers a 30 year-term for the Guaranteed program.

USDA Guaranteed Loan Credit Score

Surprisingly, the USDA does not set a minimum credit score requirement for the guaranteed program. However, lenders are allowed to set their minimum credit score criteria. Most lenders require a 640 credit score.

USDA Guaranteed Income Limits

Applicants must meet the USDA income thresholds for their area. The USDA self-assessment tool on the USDA website can help determine whether you meet the income limit for a guaranteed loan.

If you choose to use the self-assessment tool, take a minute to determine the income limit for your area.

Each year, the USDA establishes minimum income guidelines. Here are the current income limits:

As of July 13, 2023, the standard income limits for the Single-Family Housing Guaranteed Loan Program are as follows:
- For 1-4 member households: $110,650
- For 5-8 member households: $146,050*
*In regions with higher living costs, higher income limits may apply.

Area Loan Limit

There is no area loan limit or maximum purchase price limit.

Interest Rates

Determined by the lender, however, the rate is usually less than the market rate.

Upfront Mortgage Insurance

The Guaranteed loan requires an upfront mortgage insurance premium. The upfront mortgage insurance is 1% of the loan amount. The fee is known as the guarantee fee.

This fee backs up the lender if the homeowner defaults on the loan. Compared to FHA loans, the 1% fee is a bargain. The FHA charges 1.75%.

Private Mortgage Insurance

There is a monthly mortgage fee. Currently, the PMI is .35% of the loan amount, less than the FHA monthly fee. It should be noted that the monthly fee never goes away, regardless of the equity in the home. The only way to remove the fee is to refinance the loan. The monthly PMI fee is known as the annual fee.

Closing Costs and Prepaid Expenses

Unfortunately, both Direct and Guaranteed loans come with closing costs. However, these expenses can be included in the mortgage if the appraised value exceeds the loan amount. Another option to reduce closing and prepaid costs is through a seller concession. The USDA permits the seller to contribute up to 6% of the sales price towards the buyer's expenses or total costs, capped at 6% of the sales price.

For instance, if the sales price is $100,000, the maximum seller concession is $6,000. However, if the closing and prepaid costs amount to $5,000, the seller can only pay up to $5,000. Your lender can assist in determining the optimal concession percentage.

	Direct Loan	Guaranteed Loan
Application	Made through the USDA	Made through approved lenders
Income	Low and Very Low Income	Subject to area maximums
Property Size	Modest	No restriction
Term	33 years	30-years only
	(38 years for very-low-income applicants who can't afford a
	33-year loan term)
Down Payment	In most cases, no down payment is required	In most cases, no down payment is required
Credit Score	Generally, 640. However, the USDA will determine creditworthiness.	Subject to the lender requirements
Interest Rates	Determined by the USDA. Very low income home buyers might receive 1%	Subject to the lender's current interest rate
PMI	None	Currently 35% of the loan amount
Upfront fee	Nore	1% of the loan amount

Final Thoughts

The USDA programs rely on income and area criteria. The initial step in determining eligibility for the Direct or Guaranteed program is utilizing the self-assessment tool. If you decide that your income meets the requirements for the Direct program, call your local USDA office and ask to speak to a loan officer. Otherwise, consider approaching a lender that provides the Guaranteed program.

Conclusion

When contemplating a home loan, it is crucial to distinguish between USDA direct loans and guaranteed loans. The United States Department of Agriculture (USDA) provides loans, and personal factors such as income, credit score, geographical location, and others influence the choice. By the end of 2019, more than 155,000 rural households had obtained USDA home loans.

This statistic illustrates the potential advantages this loan category can offer individuals who would otherwise be unable to obtain conventional financing alternatives. In addition, direct and guaranteed loans provide notable advantages for prospective homeowners, including minimal interest rates and the absence of a down payment.

In the end, prospective homeowners must investigate before selecting the most suitable loan.
If borrowers know the distinctions between secured and guaranteed loans, they can maximize their mortgage experience and make more informed decisions about the purchase process.

SOURCE:
Comparison of Direct and Guaranteed USDA Rural Housing Loan Programs