USDA-guaranteed loans serve a range of borrowers
USDA loans outlined
- USDA loans are not used to purchase farms.
- The program offers a 100 percent financing, no-money-down payment option.
- USDA loans have maximum income restrictions and properties must be in an eligible area.
- A USDA loan has an additional underwriting step that could cause closing delays.
One of the government’s most affordable home-loan programs is also one of the most misunderstood.
United States Department of Agriculture (USDA) loans aren’t designed, as many people believe, for people to buy farms. The loans are tailored for low-to-moderate income buyers of homes. Often these are first-time buyers in rural areas, but a borrower doesn’t necessarily have to be buying a house in a tiny town to qualify.
“A lot of people think of rural as being a one-stoplight town,” said Florida originator Ricky Peacock, who is one of the top producing USDA originators in the country. “That is not necessarily how they calculate it.”
Like other government-loan programs, USDA primarily guarantees loans that are funded by private lenders. With the government’s backing, lenders can offer favorable rates and other perks to borrowers who might not otherwise qualify for conventional loans.
USDA also runs a direct program for low-income borrowers who don’t qualify for the regular guarantee loan. That program is administered by loan officers in USDA field offices and is small in comparison to the guarantee program.
The major draw of a USDA-guaranteed loan is that the program offers 100 percent financing. A borrower doesn’t have to put any money down on the house. By contrast, the Federal Housing Administration (FHA) program typically requires a minimum down payment of 3.5 percent of the purchase price.
USDA loans usually have the same rates as FHA loans. The insurance costs on USDA loans are lower over the life of the loan than FHA.
“The borrower ends up with a lower monthly payment,” said Gary Powell, a Texas originator who specializes in USDA loans. “That is the main advantage.”
Unlike FHA and Veterans Affairs (VA) loans, however, USDA loans have some special restrictions. In order to qualify, the home has to be located within eligible areas on a map that is typically updated only every decade.
USDA also sets limits on how much a family can earn and still qualify. These income levels vary by region, but the total family household income is counted.
The eligibility maps and the income requirements tend to disqualify a lot of people.
“Those are the two major downfalls that we run into in any type of USDA loan,” Peacock said. “The pros are 100 percent financing, no money down, low interest rates, low PMI [private mortgage insurance]. The downside is that you have to be income- and geographically-restricted.”
USDA also has tightened some of the standards to qualify. Powell said the agency now requires some USDA borrowers to have money in reserve to make mortgage payments after closing. A USDA borrower also has to have a well-defined credit profile.
A borrower doesn’t necessarily have to have perfect credit, however. USDA guidelines call for a minimum credit score of 580, but some lenders have layered on additional requirements, known as “credit overlays,” that require higher scores.
“As far as the pristine, high-credit scores, and everything has to be perfect, that is not the case,” Peacock said. “The USDA has a lot of flexibility in their credit underwriting.”
Another issue with USDA loans is that it takes an additional step before closing. Once the loan is approved by the underwriter, the lender has to submit the loan to the USDA for approval. In the past, this final step often took more than a month, Peacock and Powell said. More recently, however, the USDA has cut the waiting times down to a couple of days.
“Where I am located, we are getting commitments back in 24 hours, which is outstanding,” Powell said. “I have heard in other areas it is much longer than that.”