10 Things Borrowers Don’t Know About USDA Loans

If you’ve never heard of a USDA loan, you’re not alone. In fact, you might even call the benefits of USDA loans a well-kept secret. Well, not anymore!

Read on to find out all you need to know about how USDA loans work.

1) Most of the U.S. meets the rural area requirements

To qualify for a USDA loan, the home must be located in a qualified rural area, but many people are shocked to learn how the USDA defines “rural.” Generally, according to their guidelines, it includes any areas with a population of less than 35,000. According to many sources, an estimated 97% of the U.S. meets the rural area requirements.

So unless you have your sights set on living in a big city, you might qualify for a USDA loan. These loans aren’t just for rural areas or farmers.

2) USDA loans are only for primary residences.

If you’re looking for a second home or rental property, a USDA loan won’t be the right fit for you. These loans are only available for primary residences — the home you live in for the majority of the year.

3) Many property types are eligible.

When you hear “rural,” you might be thinking of a big ranch or lots of acres, but that isn't the case. USDA loans cover many different types of properties, including new construction, existing single-family homes, manufactured or modular homes, condos and townhouses. You can also use a USDA loan to buy a foreclosed home or short sale.

4) You can make too much money to qualify for a USDA loan.

USDA loans are designed for low-income borrowers, so your lender will consider your household income when evaluating your eligibility. Generally, you can’t make more than 115% of the area’s median income.

Lenders will look at the total household income, including people who won’t be obligated on the new mortgage, but there are some qualified deductions that can be subtracted.

USDA income limits reflect the cost of living and can vary depending on where you’re buying, the size of your family and more.

Talk with a USDA loan specialist if you have questions about your income and eligibility.

5) The loan program encompasses two separate types.

The catch-all term “USDA loan” actually refers to two different types of loans.

Here’s a brief primer on the differences between the two programs:

1. USDA Direct Loan: With this type of loan you are getting funds directly from the USDA. To qualify, your income must be between 50 and 80% of the average local median income. The standard repayment term is 33 years, but may go as high as 38 years for households that fall below 60% of the area median and can’t afford the shorter repayment term. These loans also come with fixed interest rates which can go as low as 1% when modified by payment assistance. Potential borrowers will apply through their local Rural Development office.
2. USDA Guaranteed Loan: These loans are like other government-backed loans, such as VA or FHA loans. Your income can’t exceed 115% of the median income in your area, and your application must be processed by a USDA-approved lender. The USDA doesn’t set any credit score requirements, but most lenders look for a minimum credit score of at least 640.

6) It’s possible to get a USDA loan even after a foreclosure or bankruptcy.

Been through some hard times financially? We get it. You might be wondering about USDA loans and bankruptcy.

The good news is that you’re still eligible for a USDA loan after bankruptcy or foreclosure. In general, USDA guidelines require a three-year waiting period to be eligible for a USDA home loan after a Chapter 7 bankruptcy or a foreclosure. Some lenders may be willing to entertain exceptions for unique cases, but those are always a case-by-case evaluation.

The waiting period after a Chapter 13 bankruptcy is one year, provided you have made 12 months’ worth of on-time payments according to the payback schedule that was established during the bankruptcy proceedings.

7) They have some of the lowest mortgage insurance fees.

When you take out a conventional mortgage and make a down payment of less than 20%, your lender will ask you to pay something called “private mortgage insurance” (PMI) to protect their investment. But traditional PMI can be expensive — the exact cost depends on your lender, but it usually ranges from 0.5% to 1.5% of the entire loan amount annually. So, if you have a $200,000 loan, that PMI payment could range from $83 to $250 per month.

The USDA charges a guarantee fee which is far more affordable. You’ll pay an upfront fee of 1% of the loan amount, and then an annual mortgage insurance fee equal to 0.35% of the loan balance. So on that same $200,000 loan, you’ll pay $2,000 upfront and $58 per month. USDA buyers can finance the upfront fee into their loan.

8) They have flexible credit guidelines.

While the USDA doesn’t specify a minimum credit score, the lender who makes the loan will likely require a credit score of 640 or more. That is the number that is required to use the USDA’s Guaranteed Underwriting System (GUS), which was designed to automate the process of credit risk evaluation. If you have a score below 640, a lender would need to manually underwrite that loan, if they decide to grant it.

Given that the average credit score for a conventional loan is about 720, these loans can be a good option for someone who has some blemishes on their credit.

9) They allow you to use a co-borrower.

A co-borrower is someone who signs on the dotted line with you, in effect saying they will take on the loan if you stop paying. With a USDA loan, you don’t have to use a co-borrower but it can be useful if it allows you to meet the income requirements or strengthens your creditworthiness. Note that the co-borrower must be someone who lives with you, and they’ll need to meet the same credit, income and debt guidelines as you.

10) They have no pre-payment penalty.

Some lenders charge a penalty if you pay your mortgage off early — this is known as a pre-payment penalty. But there’s no pre-payment penalty with USDA loans, so you can pay off the loan whenever you like.

FAQ

1. What happens if I get married after a USDA loan?

Getting married after you’ve already closed on your USDA loan won’t affect your existing mortgage. Your eligibility was based on your household income at the time of application, so changes after closing — like getting married — don’t retroactively change that. However, if you plan to refinance, get another USDA loan, or apply for assistance later, your spouse’s income will count toward household income limits. If your spouse moves in, that’s perfectly fine — USDA doesn’t restrict who can live in the home, as long as it's still your primary residence.

2. Can you pay off a USDA loan early?

Yes, you can absolutely pay off a USDA loan early, and there’s no prepayment penalty. This includes making extra payments on your principal each month or paying off the full balance in a lump sum. Paying off early can reduce the total interest you’ll pay over the life of the loan.

3. When can I sell my USDA loan home?

You can sell your USDA-financed home at any time, but there are a few important points:

• The home must be your primary residence — so if you’re still living there and ready to move, you’re in the clear.
• There’s no penalty for selling early, but you’ll need to pay off the remaining balance of your USDA loan with the proceeds from the sale.
• If you plan to buy another home using a USDA loan, you'll need to sell your current USDA-financed home first, since USDA loans are only for primary residences.