USDA loans are either guaranteed or funded by the US Department of Agriculture and designed to help low-income borrowers build …
USDA loans are either backed or funded by the US Department of Agriculture and designed to help low-income borrowers build or purchase homes in eligible rural areas. Before applying for a loan, check how you qualify, whether the pros outweigh the cons, and what the application process looks like.
[Read: Best Mortgage Lenders.]
How do USDA loans work?
Borrowers can use a USDA home loan to finance up to 100% of the appraised value of a property with no deposit, as long as they buy in certain places.
Indeed, an important part of the USDA loan program is where you can buy your house. You will need to buy in a rural or suburban area with less than 35,000 people, but that does not mean a farm.
âA common misconception about USDA loans is that they can only be used to buy farms,â says Ron Haynie, senior vice president of mortgage finance policy at Independent Community Bankers of America.
You can also use a USDA loan to buy a single family home, townhouse, condo, or even a manufactured home. In fact, most of the country is considered eligible for USDA loans, says Scott Fletcher, president of risk and compliance at Fairway Independent Mortgage Corp.
And more and more buyers are willing to relocate to rural and suburban areas, thanks to the shift to remote working caused by the pandemic, he says. âWe’ve spoken with the USDA office, and they think that’s happening with their volume,â Fletcher said.
Of course, borrowers with USDA loans can also save money up front by forgoing a down payment, and interest rates are reduced compared to rates on conventional loans. But you may have to pay mortgage insurance premiums, which protect the lender in the event of default, and closing costs.
What are the types of USDA loans?
Buyers can choose from two types of USDA loans:
Direct loans. USDA funds direct loans, reserved for low-income borrowers based on their area median. The loan term can be up to 33 or 38 years, depending on income, and the interest rate can actually be reduced to 1% after the application of the grants. Borrowers generally do not make a down payment and do not owe any money. mortgage insurance premium.
Secured loans. You must be earning less than 115% of the region’s median income to qualify for a USDA home loan guarantee.
Private lenders fund these mortgages, while the USDA insures 90% of each loan against default. This guarantee protects lenders, allowing them to offer mortgages at below market interest rates with no down payment.
But borrowers have to pay two forms of mortgage insurance: an initial guarantee fee of 1% of the loan amount and an annual fee of 0.35% of the principal balance.
[Read: Best Mortgage Refinance Lenders.]
How do you qualify for a USDA loan?
When you apply for a USDA loan, the lender will verify that you and the property meet the eligibility requirements. Qualifications are pretty standard, says Fletcher.
âIt’s a well-established program, and there aren’t a lot of traps,â he says.
For guaranteed and direct programs, loan applicants must:
– Buy a house in an eligible rural area.
– Be a U.S. citizen or an eligible non-citizen.
– Meet the income eligibility criteria depending on the location.
– Agree to occupy the accommodation as a main residence.
– Show that they cannot get an affordable loan elsewhere.
– Prove that they can participate in federal programs.
– Have a front-end debt to income ratio of 29% and a back-end ratio of 41%. The back end is the part of your monthly income that goes to pay off debts, and the front end is the amount spent solely on your mortgage.
The property must also meet these requirements:
– The accommodation must be located in a rural area.
– The property must be of modest size for direct loans or common to the area for secured loans.
– For a direct loan, the property cannot have an inground pool, the market value cannot exceed the zone’s loan limit and the house cannot be designed for income-generating activities.
– For a secured loan, the property must meet certain federal housing standards.
What are the USDA loan rates?
Your rate will depend on the type of USDA loan you want. USDA sets direct loan interest rates based on the mortgage market, but does not interfere with secured loan program rates.
The effective interest rate can drop as much as 1% after taking into account the USDA payment assistance. On the other hand, individual lenders determine the rates for USDA guaranteed loans, “just like traditional mortgages, the lower rate going to the borrower with the higher credit, the lower (loan ratio). / value) and DTI, âsays Bill Parker, director of loans at the Alabama Central Credit Union.
USDA secured loan interest rates “are very competitive with conventional mortgage products,” Parker adds.
Lenders can offer such low rates because the government guarantee protects the lender against losses.
Shopping around and comparing quotes on USDA loans can help you find the best deal. You might also get a better deal if your credit score is higher, although you don’t need a minimum credit score to qualify for a USDA loan.
What does the USDA loan application process look like?
The exact process will be different depending on whether you are applying for a USDA Direct Loan or a USDA Secured Loan. For a direct loan, start by contacting your Rural Development Office. You can shop around with private lenders, such as banks and credit unions, for a secured loan.
Here is the general process you can follow:
1. Get pre-approved for a USDA home loan. Before looking for homes, find a USDA approved lender and have them pre-approve you for a USDA loan.
The lender will check your income, debts, and assets to see if you qualify for the program. If you do, you will receive a pre-approval letter that will tell you how much you can borrow.
2. Buy a USDA approved home. Look at the USDA property eligibility card. âYou can use that map and overlay the eligible areas on something like Zillow or Realtor.com,â says Fletcher. “Or find a property and check if it’s in the qualifying area.”
3. Submit your mortgage application. Once you’ve found a home and the seller accepts your offer, you can choose a USDA-approved mortgage lender and then apply. You will provide documents to show your income, employment status, debts and assets during subscription.
The lender takes an extra step to ensure that the borrower’s income is within the program limits, Fletcher says. âIt’s critical that the borrower agrees to provide information so that we can get this loan (to USDA) before settlement day,â he says.
4. Get approved by the local USDA office. USDA will review your application and documents after the lender signs your loan. The agency will ensure that you and the property meet the eligibility requirements.
The closing time varies by lender, but the extra review adds at least a few days, says Fletcher. Once the USDA has approved your loan, you can proceed to the closing table, where you will sign the documents and pay your money to close.
[Read: Best FHA Loans.]
What are the advantages and disadvantages of USDA loans?
USDA loans can be a great option for some home buyers, but âconsumers outside of a designated rural area or above the income threshold are not a candidate for a USDA loan,â says Haynie. Consider the pros and cons before applying.
– Little money needed at the start. Most borrowers won’t need to make a down payment. Additionally, you may be able to finance repairs, closing costs, and warranty costs in the loan, and sellers can contribute up to 6% of the sale price towards closing costs.
– Several loan options. USDA loans can be used to build, improve, relocate, buy, or refinance a home.
– Flexible eligibility guidelines. You won’t have to meet minimum credit score requirements and you might even qualify with a non-traditional credit history. It could be someone who doesn’t take out loans or use credit cards.
– No prepayment penalty. Borrowers won’t pay a fee if they pay off the mortgage earlier than expected.
– Ownership restrictions. You will need to find a house in a rural area.
– Additional fees. USDA secured loans come with an annual fee, although you may be able to fund them in the loan.
– Income restrictions. All adult household members must meet low income requirements.
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