Solved! What Is a USDA Home Loan, and How Do You Qualify for One?

Q: We are looking to get out of the city and have found a great older home farther outside the suburbs than we expected. We’ve been paying high rent on a low income for so long that we haven’t been able to save money, and a local mortgage lender who rejected our application suggested that we apply for a USDA home loan, but we don’t know what that means. What is a USDA home loan?

A: A USDA home loan may be a great option for you! The program is designed to help moderate- to lower-income buyers get affordable home loans to purchase or improve houses in rural areas. For years, most Americans lived in the country on farms and fields. The industrial age brought people into the cities, but eventually people began to tire of pavement and tall buildings and spread out into suburbs. The proximity of the suburbs to the employment centers in the cities made living there more expensive, so many people who would have liked to be homeowners found that they were priced out of the market and were stuck in the cities. Simultaneously, the United States Department of Agriculture (USDA) became increasingly concerned about the dragging economy and low population in rural agricultural areas farther from cities. Realizing it could solve two problems with one program, the USDA began offering low-interest, zero down-payment mortgages and home improvement loans to homebuyers who met certain conditions and were willing to settle in rural areas. Here’s what you need to know about qualifying for USDA home loans.

A USDA home loan is a government-backed loan that offers moderate- to low-income U.S. citizens an opportunity to own a home in designated rural areas.

Mortgage rates offered by traditional lenders are based on a lender’s perception of the borrower’s ability to pay back the loan and interest and the size of the down payment. Unfortunately, many low- or moderate-income borrowers don’t have the wherewithal to pay their monthly bills and also save toward a down payment. Lower-income borrowers are also less likely to have sufficiently high credit scores, either because they haven’t established a credit record over time or because financial struggles have left some negative items on their record. A USDA mortgage removes these obstacles for borrowers interested in purchasing a home in certain rural communities with the goal of helping more people build wealth via homeownership, repopulating the rural areas, and stimulating the economy.

A USDA home loan is a down-payment-free loan, typically with low interest rates and long payback periods.

The down payment and high interest rates are often the largest obstacles for lower-income buyers to overcome. Rent, utilities, transportation, and insurance costs (plus food and medical costs) can quickly eat up a paycheck, leaving little to no extra for savings. While these borrowers may be perfectly capable of paying their mortgage each month—after all, they’re successfully paying rent—they can’t save the thousands of dollars necessary for a substantial down payment. Even if they’re able to scratch together a small down payment, the smaller down payment may result in exorbitant interest rates to protect the lender’s interests in case the borrower defaults. The USDA guarantees the loans issued under this program, so the lenders can offer loans with no down payment and low interest rates. In addition, the lenders can stretch the repayment period out farther than they can for a conventional loan—33 to 38 years, rather than the traditional 30 years—making the monthly payments smaller and easier for borrowers to manage.

There are three types of USDA home loan programs: loan guarantees, direct loans, and home improvement loans.

The USDA loan program provides several avenues for lower-income borrowers to purchase or improve their home. The first path is through guaranteed loans: Local lenders choose to participate in the program and commit to upholding the USDA regulations in lending, and in exchange the USDA guarantees the loan (if the borrower defaults, the USDA will cover the lender’s financial losses, so the lender is at less risk). This way, the borrower can work with a local bank and develop a relationship with a creditor that will build community and support local business while providing a service to the borrower. In cases where this is not an option, such as borrowers whose income is below the threshold most local lenders set, the USDA will issue the loan itself. The parameters and income requirements for these loans vary by region, but they also tend to have extremely low interest rates. Finally, the USDA offers loans and grants to help borrowers upgrade or repair their homes; a combination of grants and a USDA construction loan provides up to $27,500 in assistance to help borrowers improve the value and condition of their home.

USDA loans differ from conventional loans in several ways, such as in down payment requirements.

USDA loans have no down payment requirement, but that’s really only the first of many ways in which USDA loans benefit borrowers. Those with questionable credit histories (there is no set minimum credit score) or nontraditional credit references can still apply and be approved. Origination fees and rates are lower than they are with traditional loans as well. However, USDA loans are limited to homes in rural (or occasionally underserved suburban) areas, so borrowers can’t choose a home anywhere they would like. The USDA also reserves the right to limit the size and function of the home being purchased. While the loan must be for a home that is safe and sound, it can’t be more than 2,000 square feet, must have a market value lower than the local market value, and can’t have a swimming pool or be used for income-generating activities. This is to make certain that the communities and properties that most need the stimulation the program provides will be first in line. Finally, USDA loans can take a little longer to close. Borrowers with higher credit scores can see closings in as little as 3 weeks, but those with unconventional credit histories or whose eligibility requires more verification can take up to 60 days to close.

Applicants must meet certain requirements, such as not exceeding the predetermined income limits.

The applicants themselves must also meet certain eligibility criteria. The buyers must be in a position where they can verify that they don’t have safe, sanitary, and decent housing and that they cannot get a loan that they can manage from other lenders. The property the borrowers are purchasing must be their primary dwelling: USDA loan requirements prevent using the funds for second or rental properties, and they require that a home be present on the property, as they do not offer land loans. The USDA has determined income limits based on regional income averages, and the borrower’s income and assets cannot exceed that limit. These limits vary because housing prices cover such a wide range across the country; a low-income borrower in California may have a higher income than a well-to-do homeowner in an area where housing prices are lower. Check your region to see what the income limits are. Additionally, the borrower must be a citizen of the United States.

Only participating lenders can issue USDA loans.

The USDA Home Loan Program is tightly regulated to enable the department to help those who are most in need. As a result, the number of banks and mortgage lenders who can offer USDA loans is limited to those who commit to fully meeting the lending and servicing requirements the program demands. The group of participating lenders is also limited so that the USDA can carefully monitor the lending and repayment process. Some lenders prefer not to deal with the extra paperwork and monitoring, while others aren’t willing to take the risk of lending money to lower-income borrowers or those with credit challenges, even with the backing from the government. You may need to call around to local lenders you’d like to work with, or consult the USDA eligibility page for contact information for participating lenders in your area or online.