Unlocking Homeownership: The Pros and Cons of USDA Loans

A very big pretty home in the middle of a big field that was financed with a USDA loanUSDA loans are an attractive mortgage option for rural homebuyers. With 100% financing, low interest rates, and no monthly mortgage insurance, these government-backed loans make homeownership achievable for many. But USDA loans aren't for everyone. When considering a USDA home loan, you need to know the pros, cons, requirements, and more.

What is a USDA loan?

The U.S. Department of Agriculture (USDA) insures mortgages known as USDA loans or Section 502 loans. They help low- to moderate-income buyers in eligible rural and suburban areas purchase a home with no down payment.

What are the benefits of USDA loans?

Here are some of the biggest pros of USDA loans:

100% Financing with No Down Payment

USDA loans require no down payment. This makes them one of the only mortgages and VA loans to offer 100% financing. With a conventional loan, you usually need a down payment of at least 3–5%.

Low-interest rates

Interest rates on USDA loans are very competitive, often beating out conventional loans. This makes them affordable, even with 100% financing.

No Monthly Mortgage Insurance

Instead of monthly mortgage insurance, like with an FHA loan, USDA loans charge an upfront guarantee fee rolled into the mortgage amount. This results in lower monthly payments.

Low credit score requirements

USDA loans are available to borrowers with credit scores as low as 640. This flexible credit requirement opens homeownership to more buyers.

Low debt-to-income ratio

With a USDA loan, your front-end debt-to-income ratio can be as high as 29%. This is less strict than conventional loans, allowing buyers to qualify for a higher loan amount.

Use for New Construction

USDA loans can be used to build a new home on eligible land. This unique option sets them apart from most mortgage programs.

What are the drawbacks of USDA loans?

However, USDA loans aren't perfect. Here are some essential cons to consider:

  • Limited to Specific Locations: USDA loans are only available in designated rural areas and some suburban neighborhoods. The property's location must be eligible.
  • Stricter Home Requirements: The home must be modest and typical for the area. Luxury homes or large properties may not qualify.
  • Potentially Longer Closing Time: USDA loans can take longer to close due to extra paperwork and underwriting. You may need more patience.
  • Refinancing Limitations: Refinancing or buying out a co-signer on a USDA loan is restricted compared to conventional loans.

  • Upfront Guarantee Fee: While you avoid monthly mortgage insurance, an upfront guarantee fee of 1% of the loan amount is required.
  • Home Equity Limitations: You cannot take out a home equity loan for over 15 years on a USDA-financed home.

Who is eligible for a USDA loan?

To qualify for a USDA home loan, borrowers must meet specific eligibility requirements:

  • Location: The home must be in an eligible rural area as defined by the USDA Property Eligibility Tool. Approved sites include rural towns and some suburban neighborhoods.
  • Income Limits: Household income must be below the limit for the county where the property is located. View income limits by state on the USDA website.
  • Credit History: A minimum credit score of 640 is required. However, buyers with limited or non-traditional credit may still qualify.
  • Debt-to-Income Ratio: Your total DTI must be below 41% and your front-end DTI below 29%.
  • Citizenship: At least one borrower must be a U.S. citizen. Permanent resident aliens may also qualify.

How do I apply for a USDA home loan?

Follow these steps to get a USDA mortgage:

  1. Check your eligibility based on location, income, credit score, and other requirements. Use the USDA property eligibility and income eligibility tools.
  2. Obtain preapproval from a lender that is USDA-approved. This shows sellers that you're a serious buyer.
  3. Make an offer and enter a purchase agreement when you find an eligible property.
  4. Complete the mortgage application and submit all required documentation to your lender.
  5. Work with your lender throughout the underwriting process to obtain approval.
  6. Your lender will guide you through the closing process.
  7. You'll complete the final loan documents and receive the keys once the sale closes!

Frequently Asked Questions About the Pros and Cons of USDA Loans

Q: What are USDA loans?

A: USDA loans, or USDA Rural Development loans, are mortgage loans backed by the U.S. Department of Agriculture. They are designed to help low- and moderate-income individuals and families buy homes in eligible rural areas.

Q: What are the benefits of USDA loans?

A: The main benefits of USDA loans are that they offer a zero down payment option, low interest rates, and lower mortgage insurance rates than other loan types. Additionally, USDA loans have flexible credit requirements and can be used to finance both new construction and existing homes.

Q: How do I qualify for a USDA loan?

A: To qualify for a USDA loan, you must meet specific eligibility criteria. This includes income limits based on the area where the home is located, having a decent credit history, and being able to afford the mortgage payment.

Q: What are the loan requirements for USDA loans?

A: The loan requirements for USDA loans include meeting income eligibility requirements, having a credit score of at least 640 (although some lenders may accept lower scores), and having the property located in an eligible area designated by the USDA.

Q: Can I use USDA loans to buy any property?

A: USDA loans can only buy homes in eligible rural areas. The property must be a modest, single-family home, the applicant's primary residence.

Q: Are USDA loans only for first-time homebuyers?

A: USDA loans are available to first-time and repeat homebuyers if they meet the eligibility criteria.

Q: What is mortgage insurance, and do USDA loans require it?

A: Mortgage insurance is a type of insurance that protects the lender in case the borrower defaults on the loan. USDA loans require mortgage insurance in the form of upfront and annual mortgage insurance premiums.

Q: How long do I have to pay mortgage insurance premiums with USDA loans?

A: With USDA loans, the annual mortgage insurance premiums are paid for the life of the loan. However, the upfront mortgage insurance premium can be financed into the loan amount.

Q: How do USDA loans compare to FHA loans?

A: USDA and FHA loans are government-backed loan programs but have different eligibility requirements and property location restrictions. FHA loans may be more suitable for borrowers not meeting USDA loans' income and location requirements.

Q: Can I get a USDA loan through any mortgage lender?

A: No, USDA loans are only offered by approved USDA lenders. The USDA has vetted and approved these lenders to provide loans under the USDA loan program.

Key Takeaways on USDA Loans

While USDA loans offer nice perks, understand the limitations and weigh the pros and cons before applying. Consider working with a loan officer familiar with these specialized mortgages. If the program fits your needs, USDA financing can be an affordable path to homeownership.

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