A Guide to USDA Home Loans

·7 min read

USDA loans are either backed or funded by the U.S. Department of Agriculture and designed to help low-income borrowers build or buy homes in eligible rural areas. Before applying for a loan, check out how to qualify, whether the benefits outweigh the drawbacks and what the application process is 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 down payment, as long as they buy in certain locations.

Indeed, an important piece of the USDA loan program is where you can purchase your home. You will need to buy in a rural or suburban area with a population of less than 35,000, but that doesn't mean a farm.

"A common misconception about USDA loans is that they can only be used to purchase farms," says Ron Haynie, senior vice president of mortgage finance policy at the Independent Community Bankers of America.

You can also use a USDA loan to buy a single-family home, a town house, a condo or even a manufactured home. In fact, most of the country is considered eligible for USDA lending, says Scott Fletcher, president of risk and compliance at Fairway Independent Mortgage Corp.

And more buyers are willing to move to rural and suburban areas, thanks to the pandemic-prompted shift to remote work, he says. "We spoke with the USDA office, and they think that is occurring with their volume," Fletcher says.

Of course, borrowers with USDA loans can also save money upfront by forgoing a down payment, and interest rates are discounted compared with rates on conventional loans. But you may need to pay mortgage insurance premiums, which protect the lender in case of default, and closing costs.

What Are the Types of USDA Loans?

Buyers can choose from two types of USDA loans:

Direct loans. The USDA funds direct loans, which are reserved for borrowers with low income based on the median for their area. The loan term can be as long as 33 or 38 years, depending on income, and the interest rate may effectively be reduced to 1% after subsidies are applied. Borrowers typically make no down payment and owe no mortgage insurance premium.

Guaranteed loans. You must earn less than 115% of the area's median income to be able to qualify for a USDA home loan guarantee.

Private lenders fund these mortgages, while the USDA insures 90% of each loan against default. That guarantee protects lenders, allowing them to offer mortgages with below-market interest rates and no down payments.

But borrowers must pay two forms of mortgage insurance: an upfront 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 Can You Qualify for a USDA Loan?

When you apply for a USDA loan, the lender will check that you and the property fit eligibility requirements. The qualifications are pretty standard, Fletcher says.

"It's a well-established program, and there are not a lot of trapdoors," he says.

For both the guaranteed and the direct programs, loan applicants must:

-- Buy a home in an eligible rural area.

-- Be a U.S. citizen or an eligible noncitizen.

-- Meet income eligibility requirements based on location.

-- Agree to occupy the home as their primary residence.

-- Show they can't 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 what portion of your monthly income goes toward paying debts, and the front end is the amount spent on your mortgage only.

The property will also need to meet these requirements:

-- The home must be in a rural area.

-- The property must be modest in size for direct loans or common to the area for guaranteed loans.

-- For a direct loan, the property can't have an in-ground pool, the market value can't exceed the area's loan limit and the home can't be designed for income-producing activities.

-- For a guaranteed loan, the property must meet certain federal housing standards.

What Are USDA Loan Rates?

Your rate will depend on the type of USDA loan you want. The USDA sets interest rates for direct loans based on the mortgage market but does not get involved with rates in the guaranteed loan program.

The effective interest rate may drop to as low as 1% after factoring in the USDA's payment assistance. On the other hand, individual lenders determine rates for USDA guaranteed loans, "just like traditional mortgages, with the lowest rate going to the borrower with the highest credit, lowest (loan-to-value ratio) and DTI," says Bill Parker, director of lending at the Alabama Central Credit Union.

Interest rates on guaranteed USDA loans "are very competitive with conventional mortgage products," Parker adds.

Lenders can offer such low rates because the government guarantee protects the lender against loss.

Shopping around and comparing quotes on USDA loans can help you find the best deal. You could also get a better deal if you have a higher credit score, even though you don't need a minimum credit score to qualify for a USDA loan.

What Is the Application Process Like for a USDA Loan?

The exact process will differ depending on whether you're applying for a USDA direct loan or a USDA guaranteed loan. For a direct loan, start by contacting your local Rural Development office. You can shop with private lenders, such as banks and credit unions, for a guaranteed loan.

Here's the general process you may follow:

1. Get preapproved for a USDA home loan. Before searching for homes, find a USDA-approved lender and ask the lender to preapprove you for a USDA loan.

The lender will check your income, debt and assets to see whether you qualify for the program. If you do, then you will receive a preapproval letter that tells you how much you can borrow.

2. Shop for a USDA-approved home. Look at the USDA's property eligibility map. "You can use that map and overlay eligible areas against something like Zillow or Realtor.com," Fletcher says. "Or find a property and then check if it's in the eligible area."

3. Submit your mortgage application. After you've found a home and the seller accepts your offer, you can choose a USDA-approved mortgage lender and then apply. You'll provide documents to show your income, employment status, debts and assets during underwriting.

The lender takes an additional step to make sure the borrower's income meets program limits, Fletcher says. "It's critical that the borrower is engaged in providing information so we can get that loan into (the USDA) prior to the settlement day," he says.

4. Get approved by the local USDA office. The USDA will review your application and documents after the lender signs off on your loan. The agency will make sure you and the property fit eligibility requirements.

The closing timeline varies by lender, but the extra review adds at least a few days, Fletcher says. Once the USDA approves your loan, you can head to the closing table, where you'll sign the paperwork and pay your cash to close.

[Read: Best FHA Loans.]

What Are the Pros and Cons of USDA Loans?

USDA loans can be a great option for some homebuyers, but "consumers outside of a designated rural area or who exceed the income limit threshold are not candidates for a USDA loan," Haynie says. Consider the pros and cons before you apply.


-- Little cash needed upfront. Most borrowers won't need to make a down payment. Plus, you may be able to finance repairs, closing costs and the guarantee fee into the loan, and sellers can contribute up to 6% of the sales price toward closing costs.

-- Several loan options. USDA loans can be used to build, improve, move, purchase or refinance a home.

-- Flexible eligibility guidelines. You won't have to meet minimum credit score requirements and may even qualify with a nontraditional credit history. That can be someone who doesn't take out loans or use credit cards.

-- No prepayment penalties. Borrowers won't pay fees if they pay off the mortgage ahead of schedule.


-- Property limitations. You'll need to find a home in a rural area.

-- Extra fee. Guaranteed USDA loans come with an annual fee, although you may be able to finance it into the loan.

-- Income restrictions. All adult household members must meet low-income requirements.