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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.

How USDA Loans Work

The USDA loan is a zero-down mortgage option available to a large portion of the United States. USDA loans are made by private lenders and guaranteed by the U.S. Department of Agriculture (USDA). They are offered to home buyers in less industrialized areas as a way to boost homeownership in rural areas.

USDA loans work similar to other government backed mortgage options. Homebuyers will work with a USDA lender, become preapproved, put in an offer on a home, go through the USDA loan appraisal, lender underwriting and finally on to closing.

While the $0 down advantage is key, these government-backed loans offer a host of other big benefits, too. Here are 10 facts and benefits of USDA loans that might surprise you.

1) Most of the U.S. is eligible.

You can purchase with a USDA loan only 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. In fact, an estimated 97 percent of the U.S. is eligible for USDA lending.

So unless you have your sights set on the bright lights of an urban area, you are probably in luck to qualify for a USDA loan. These loans aren’t just for rural areas or farmers.

2) USDA loans are only for primary residences.

Looking for a sweet second home or even a rental property? Sorry, a USDA loan won’t be for you. Because if you’re asking, “Are USDA loans only for primary residences?”, the answer is yes. The requirements state that it must be used for a “primary residence,” where you live all the time.

3) Many property types are eligible.

When you hear “rural,” you might be thinking a big ranch or lots of acres, but that isn't the case. USDA loans cover just about any type of dwelling that you might be interested in, from new construction and existing single-family homes to manufactured or modular homes and even condos and townhouses.

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

While USDA loans aren’t for every property, they aren’t for every budget, either. The USDA and lenders consider your household income when evaluating your eligibility. Generally, you can’t make more than 115 percent 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 percent of the average local median income. It comes with a potentially longer term, up to 38 years as compared to the standard 30, and also will offer lower interest rates that will make your monthly payment more affordable. Potential borrowers need to work directly with their local Rural Development office.
  2. USDA Guaranteed Loan: These loans are like other government-backed loans, such as VA or FHA loans. This one uses the household income numbers referenced above (115% of median income in your area) and must be done through a USDA-approved lender. Because the USDA is “guaranteeing” these loans, their guidelines are a little more stringent, including that the borrower must have a credit score of at least 640.

6) You can get a USDA loan even if you have had 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 can still obtain 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 seek a conventional mortgage and make a down payment of less than 20 percent, your lender will ask you to pay something called “private mortgage insurance” (PMI) to protect their investment. But traditional PMI can be expensive, running about 0.5 to 1 percent of the entire loan amount annually. So, if you have a $200,000 loan, that PMI payment could run a costly $200 a month.

USDA mortgage insurance is far more affordable. You’ll pay an upfront fee of 1 percent of the loan amount, and then an annual mortgage insurance fee equal to 0.35 percent 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.

One of the benefits of USDA loans is that there is no penalty for prepayment. While it seems hard to believe that you would pay more to pay off your loan, some lenders require you pay a penalty if you pay off your loan before a specified time. But with a USDA loan you have no pre-payment penalty, which means that if you refinance, sell your house or win the lottery, you can pay off the loan whenever you like.