By Kimberly Dawn Neumann
With mortgage interest rates near 7% and home prices hovering at a national median of $425,000, many homebuyers might be wondering how they’ll be able to pay for a property, and searching for ways to reduce costs.
While there are a variety of mortgages aimed at helping homebuyers afford a home—such as FHA loans and VA loans—one type that’s often overlooked are USDA loans, which offer excellent terms to those who qualify, including a 0% down payment and low interest rates.
Here’s everything you need to know about USDA loans, and whether they’re right for you.
What is a USDA loan?
A USDA loan is a mortgage that is either issued or guaranteed by the United States Department of Agriculture. Also known as Section 502 or 504 loans, these programs are specifically reserved for people with low or moderate incomes looking to buy in designated rural parts of the country.
According to the Housing Assistance Council, 97% of U.S. land is located within USDA loan–eligible boundaries, where about one-third of all Americans currently reside. (Homes for sale listed on Realtor.com will typically indicate if they’re eligible for USDA loans.)
However, relatively few people take advantage of these loans, with the USDA estimating that only 99,000 borrowers have these mortgages currently. Many may presume these loans are relegated only to extremely remote areas such as farmland, when the reality is that USDA mortgages are surprisingly versatile. They can be used to purchase townhouses as well as single-family homes, fund new construction, or renovate an existing home.
“USDA home loans are a fantastic option for qualified homebuyers and aren’t limited to rural properties like farms,” says Tan Tunador, a senior loan officer with Atlantic Coast Mortgage in Loudon County, VA.
Types of USDA loans
There are three main types of USDA loans, each with its distinct benefits and pool of eligible borrowers:
1. Direct loans
These loans originate directly from the USDA, with no private lender involved. They are usually reserved for very low-income applicants with extremely generous terms, like 0% down and very low interest rates.
2. Guaranteed loans
These mortgages are offered by private lenders that have been vetted and approved by the USDA, which then guarantees the loan. This, in turn, reduces the risk for lenders because if the homebuyer defaults on the mortgage, the government will pay the lender back. This enables USDA-approved lenders to pass along extremely attractive loan terms to borrowers, including 0% down payment and low interest rates.
3. Repair/renovation loans and grants
These grants allow homeowners to repair or improve their home. They may also be available to low-income senior citizens who need to upgrade for health or safety reasons.
Benefits of USDA home loans
USDA loans come with a variety of benefits that can help make homeownership more affordable:
- 0% down payment: Loans of up to 100% of the home’s value allow eligible buyers to put no money down. Compared with other loans, which may require anywhere from 3% to 20% down, this amounts to huge savings.
- Lower interest rates: “USDA loan rates are competitive and may be lower than those available through FHA loans and other programs,” says Sue Barber, national sales manager at Wells Fargo Home Mortgage. In fact, in some cases, the interest rate may be as much as 50% less than the market rate, resulting in much lower monthly mortgage payments.
- Reduced mortgage insurance: Typically, borrowers paying less than 20% down on a home purchase will have to also pay for mortgage insurance. This protects the lender in case the borrower defaults on paying back the loan. But the rates on insurance for USDA loans is generally lower—currently about 1% upfront and 0.35% annually for the life of the loan. For comparison, FHA loans charge 1.75% upfront and around 0.80% to 1.05% annually for insurance.
- Lower credit score requirements: “There is no minimum credit score requirement for this type of loan,” says Jill Gonzalez, an analyst for WalletHub. “However, borrowers still need to demonstrate they have the ability and willingness to repay the loan.” And a good credit score is still better to have, as it will influence your ability to get the best rate possible.
- Lower closing costs and other fees: Another major savings opportunity are low origination fees if working with a USDA-approved lender. Closing costs, legal fees, and other prepaid fees may typically be rolled into the loan balance and paid off over time. Lastly, “There is no limit on the amount of gift funds that a borrower can use, and alternative credit may be considered,” says Barber.
The restrictions of USDA loans
The big catch with USDA loans is that they are geographically and income-restricted: The property must be in a designated rural area, and there are maximum borrower income limits based on the specific area. Here’s a closer look at these restrictions:
- Geographic limitations: “The home must be located in an eligible rural area with a population of no more than 35,000,” says Gonzalez. That being said, rural does not mean living in the middle of nowhere. In some cases, the suburbs may qualify, so be sure to research your area.
- Income thresholds: Borrowers must meet specific income requirements based on where they live, and if those income limits are exceeded, they cannot qualify. Generally, an individual is considered a low-income earner if his or her household income is less than double the federal poverty level, or FPL. In 2022, the Department of Health and Human Services determined that the FPL for the 48 contiguous states and the District of Columbia is $27,750. So if you double that, an individual cannot make more than $55,500 and qualify for a USDA loan. But again, this varies widely by area, so check your local stipulations.
- Primary residence stipulations: “Only single-family, owner-occupied homes can be financed,” says Barber. “Duplex homes, second homes, or investment properties are not eligible.” In other words, you can’t get a USDA loan for that vacation home you’ve always wanted.
Qualifications for USDA loans
Qualifications for USDA loans will vary based on the type of loan a borrower is getting. Here’s a breakdown of some of the key eligibility requirements:
Direct loan applicant requirements
- Must be without decent, safe, sanitary housing.
- Must be unable to obtain financing from other sources.
- Adjusted income must be at or below the low-income limit for the area.
- Must meet citizen or eligible noncitizen requirements.
- Must agree to occupy the dwelling as a primary resident, and not for income-producing activities.
- Home purchased must not exceed 2,000 square feet or have an in-ground swimming pool.
Guaranteed loan applicant requirements
- Household income may not exceed 115% of the median income in the area.
- Applicants must have a steady income and enough savings/assets to make mortgage payments for at least 12 months.
- Must agree to occupy the dwelling as a primary residence.
- Must be a U.S. citizen, a U.S. noncitizen national, or a qualified alien.
Repair/renovation loan and grant applicant requirements
- Must be the homeowner and occupy the house for which they’re applying for the loan.
- Unable to obtain affordable credit elsewhere.
- Have a household income that does not exceed their county’s “very low income” threshold (50% of the area median income).
- For grants, must be 62 or older.
- Must use the funds to repair or improve the house, or remove health or safety hazards.
USDA loans: How much can you borrow?
How much you can borrow depends on which USDA loan you’re attempting to get.
Direct loan: This will vary, but you can use the USDA’s Self-Assessment tool to get an estimate based on a preliminary review of factors like your income, debt, property location, and number of inhabitants.
Guaranteed loan: Since you’ll be working with a lender, there is no maximum limit on what you can borrow, as it will be determined by your credit score, debt-to-income ratio, and other criteria established between you and the lender.
Repair/renovation loan: The maximum loan amount is $40,000, and the maximum grant amount is $10,000. In some cases, an applicant may qualify for both a loan and a grant, making the ultimate payment $50,000 in this category.
What is the interest rate with a USDA loan?
With current interest rates on conventional loans approaching 7%, USDA loan interest rates are extremely forgiving by comparison. While the exact rate will vary based on the borrower and the time of closing, here’s a snapshot of what borrowers can expect:
- Direct loans: As of Nov. 1, 2022, the current interest rate for a USDA direct loan is 3.25% for low-income and very low-income borrowers. This rate, at closing, remains fixed for the life of the loan, which can be paid back over 33 to 38 years—a longer time frame than the usual 30-year fixed mortgage.
- Guaranteed loan: The interest rate will be determined for the borrowers by the USDA-approved lender with whom they’re working, but it may generally be a bit lower than conventional loans from traditional lenders.
- Repair/renovation loan: The interest rate is set at 1%, with a 20-year payback term.
What are the costs associated with a USDA loan?
“USDA loan closing costs range between 2% to 6% of the home’s purchase price,” says Gonzalez. “They include fees for things like home appraisal, mortgage processing, and title search.”
There is also the USDA’s own mortgage insurance fee, also known as the “guarantee fee,” which typically costs about 1% of the loan amount.
The good news is there are ways to have many of these fees rolled into the overall loan structure, where they can be paid back over the life of the loan.
Where can I find a USDA loan?
Homebuyers who want to apply for a USDA loan can consult with their local Rural Development agency, which can connect them with a housing specialist or a USDA-approved lender.
Prospective borrowers might also want to research eligibility requirements, particularly in terms of income limits and the area where they’re looking to buy. But don’t be afraid to ask for help.
“A consumer will find it easier to have their agent or lender determine eligibility,” says Tunador. “If a buyer is shopping for home financing and looking for low- or no-down payment options, they should ask their mortgage lender if a USDA loan is a possibility.”