Afraid You Can't Buy a Home? A USDA Mortgage May Be for You

Family spending time together on the front porch of a rural home.

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A USDA mortgage makes it possible for some home buyers to compete in an overheated market by offering a more affordable loan.

The current housing market is undeniably red hot. While purchasing a home can be a challenge for anyone, it is particularly tough for a buyer with low income and a low down payment. If you find yourself in that boat, don't count yourself out of the housing market just yet. Maybe you just need the right kind of mortgage. USDA mortgage loans are an often-overlooked way to become a homeowner.

What is a USDA Loan?

The USDA mortgage loan is backed by the United States Department of Agriculture (USDA), and designed to help low- and moderate-income Americans purchase homes. In addition to offering low interest, a USDA loan allows you to buy a home with no money down. The caveat is that a USDA loan can only be used to purchase a home in an eligible rural area.

What is an eligible rural area?

Before images of moving to the countryside fill your head, it's important to know that the USDA interpretation of rural is different from the average interpretation. Yes, you can use a USDA mortgage to purchase a home in the country, but suburban areas also qualify as rural in the USDA's book.

Your first step is to check the USDA's property eligibility website to learn if an area where you would like to buy a home qualifies. If you have any trouble finding an eligible area, ask a real estate agent to help you conduct a quick search. You may be surprised to find how many neighborhoods you have access to.

How does a USDA loan work?

A USDA loan (officially called the "Section 502 Guaranteed Loan Program) helps approved lenders provide home loans to low- and moderate-income buyers. Here's how: The USDA promises lenders it will repay the lender 90% of the loan note if you fail to make your monthly mortgage payments. Knowing this, lenders feel more comfortable working with non-traditional buyers.

Once approved for a USDA mortgage, you are free to purchase, build, rehab, or relocate a dwelling in an eligible area. As mentioned, that eligible area may be out in the country or in a suburban neighborhood that is USDA-approved.

Who's eligible to apply?

To apply for a USDA loan, you must meet these three criteria:

1. Income eligibility

Your household income cannot exceed 115% of the median household income -- for the area in which you hope to buy.

These USDA income guidelines make it easy to learn if you're eligible. To give you an example of what you can expect, here are the current income limits for Grand Junction, Colorado:

Program Type 1 Person 2 Person 3 Person 4 Person 5 Person 6Person 7 Person 8 Person
Very Low Income $36,750 $36,750 $36,750 $36,750 $48,550 $48,550 $48,550 $48,550
Low Income $58,800 $58,800 $58,800 $58,880 $77,600 $77,600 $77,600 $77,600
Moderate Income -Guaranteed Loan $95,750 $95,750 $95,750 $95,750 $126,400 $126,400 $126,400 $126,400
Source: USDA.

2. You must personally occupy the dwelling as your primary residence

In other words, a USDA mortgage cannot be used to pay for a second home or to purchase a rental property.

3. You must be a U.S. citizen, U.S. non-citizen national, or a qualified alien

What makes the USDA loan unique?

Several characteristics set the USDA loan apart from other mortgage programs. They include:

  • The interest rate is based on the property's value at the time of mortgage approval or closing, whichever rate is lower.
  • The loan term (how long you have to repay the loan) usually stretches to 33 years, but can extend up to 38 years for very-low-income borrowers.
  • No down payment is required.
  • Although no specific credit score is required to land a USDA loan, most USDA-approved lenders look for a score of at least around 640.
  • There is no set acreage limit. If you can qualify for the loan amount on a large piece of land, it is possible to purchase it.
  • A USDA loan can cover the costs of repairs and rehabilitation.
  • USDA funds can be used to cover site costs, such as grading, seeding or sod installation, walks, fences, driveways, and trees.
  • Funds can also be used to purchase essential household equipment, like wall-to-wall carpeting, refrigerators, washers, dryers, ovens, ranges, and heating and cooling equipment.

How to apply for a USDA loan

The USDA has a network of approved lenders, and these lenders are your point of contact. Just as you would rate-shop lenders for a conventional mortgage, comparing USDA lenders is crucial. Some will offer better rates and terms than others, so checking them out can save you thousands in interest over the years.

Perhaps the only fly in the ointment when it comes to USDA mortgage loans is that borrowers are required to pay mortgage insurance fees. Collecting this fee allows USDA to guarantee the loans of all USDA borrowers.

The fee is paid in two parts. First, an upfront guarantee fee equal to 1% of the loan amount is paid at closing, and more often than not, is financed into the loan. Let's say you're borrowing $200,000. An extra $2,000 is tacked onto your loan amount to cover the mortgage insurance fee. The good news is that this fee is 0.75% lower than the mortgage insurance fees paid on FHA loans, and 1.15% less than the insurance fees collected on VA loans.

You also pay an annual fee of 0.35% of the loan balance. While the lender calculates the fee annually, it's split into 12 equal payments, and added into your monthly mortgage payments. Again, let's imagine that your loan balance is $200,000. Your annual mortgage insurance fee is $700. Divided by 12, that adds a little over $58 to your monthly payment.

If you hope to buy a home, but are worried you don't earn enough money or have a large enough down payment to compete, a USDA mortgage lender may make it possible to purchase your slice of the American Dream.

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