Most mortgage loans require you to make a down payment. But if you’re willing to live in a rural setting, you don’t have to put money down with a USDA loan. This government-backed financing option offers several advantages with a few compromises, such as limited locations that qualify. But it’s important to understand the USDA loan requirements before committing to this mortgage vehicle.
Take the time to better comprehend how USDA loans work and the USDA loan requirements involved, including minimum credit score, income limits, and debt-to-income and loan-to-value ratios needed.
A USDA loan is a government-backed mortgage loan that helps lenders provide financing designed to assist low-to-moderate-income buyers seeking to purchase properties in specifically designated rural areas around the country. The goal of the USDA loan program is to boost homeownership in and quality of life within small towns and rural areas eligible for this type of financing.
Among the benefits of USDA loans, no down payment is required, no cash reserve is needed, there are no loan limits, and credit guidelines are flexible. What’s more, being that it is government-backed, a USDA loan can be had for a relatively low fixed interest rate.
These are all enticing advantages to first-time home buyers, many of whom lack the funds needed for the down payment required by conventional financing.
“However, USDA loans can only be used by homes in specified rural areas. That means you’ll have to quit the busy city life for a more pastoral setting. But the good news is that several suburbs in or close to large cities fall under the USDA’s expansive definition of ‘rural,’” explains Lyle Solomon, a real estate attorney and financial expert with Oak View Law Group. “And contrary to popular misconceptions, working in the agricultural sector is not required to obtain a USDA loan. The main factors determining eligibility are your household size, location, and income.”
Eager to learn more about eligibility rules for USDA loans? Here’s a breakdown of what is required.
To be a candidate for a USDA loan, you must purchase a home in a specifically designated rural area of the country. Per the USDA, these include locations with a population of 10,000 or less in areas that are rural in character or in open country, as well as locations with a population of 20,000 or less but not situated in a Metropolitan Statistical Area (MSA). To find a property eligible for a USDA loan, visit the USDA’s property eligibility site.
To get a USDA loan, many lenders will require a minimum credit score of 620, but a score of 640 or higher is recommended.
“Remember that there’s always more to credit than just your score. It’s best to ask your lender what other credit history must be demonstrated, too. Things like a good past housing history and other good credit behavior shown on your credit report is always important,” says Ronald Schwartz, senior mortgage loan officer for Embrace Home Loans.
Additionally, your household earnings must not exceed 115% of the median income in the home-for-sale area. Keep in mind that household income refers to the earnings of all persons dwelling in the home – not just the mortgage borrower.
To check if you meet income requirements, visit the USDA’s income eligibility page.
A lender providing a USDA loan will look closely at your employment history.
“There is no set minimum period that an applicant must have worked for a particular employer. However, the lender must confirm the applicant’s job for the previous two full years as well as the fact that their income has been steady,” explains Solomon.
Furthermore, you must be employed full-time and considered a good candidate to service the loan.
“Self-employed individuals are also considered, but they may have a harder time getting approved if they can’t verify income,” cautions Dennis Shirshikov, a strategist with Awning.com and a professor of economics and finance at City University of New York.
Your debt-to-income (DTI) ratio indicates the percentage of your monthly gross income devoted to paying down debt. Your lender will also scrutinize this metric.
“Once your income is verified by the lender, the USDA loan program targets maximum DTI ratios of 29% for housing and a maximum of 41% for all recurring monthly expenses,” Schwartz continues. “This is a little more conservative than other loan programs but not a deal-breaker considering they provide up to 100% financing.”
Solomon points out that a 640 credit score typically allows a maximum DTI ratio of 41%, while a credit score of 680 or higher may allow a DTI ratio up to 43%.
Aside from the rule that the home must be set in an approved geographical location, there are other rules about the property you must abide by.
First, You must occupy the home as a primary residence; the dwelling must not be used as an investment property or second home. Second, the property must be a single-family home, condominium home, planned unit development home, modular home, or mobile home. Third, the residence must provide between 400 and 2,000 square feet of living space. Fourth, the home has to be structurally sound and pass an appraisal that complies with USDA property guidelines.
“In addition, the home must be a non-farm property that is typical in size for the area. Manufactured homes must meet certain eligibility requirements as well,” adds Schwartz.
The good news is that the USDA program will lend up to 100% of the value of the home, which means that typical LTV restrictions don’t apply.
“The entire loan amount for the borrower may not exceed 102% of the appraised value of the property, for a maximum LTV ratio of 102%,” Solomon says. “So long as your LTV does not exceed 102%, you may also finance closing costs like lender, title, escrow, attorney, and appraisal fees. However, the appraised property value has to be higher than the contracted price at which you agree to acquire the property for closing costs to be bundled into the mortgage amount.”
More good news: Private mortgage insurance is not required for a USDA loan, even though you may not be putting any money down.
“Instead, the program requires you to pay a guarantee fee, which serves as a low-cost type of mortgage insurance. This fee is equivalent to 1% of your loan amount due upfront. Then, you also need to make monthly guarantee fee payments that are calculated as 0.35% of your loan amount divided by 12 months,” says Schwartz. “This guarantee fee applies to all USDA loans whether or not you make a down payment.”
Your one-time guarantee fee due at closing can be financed into your loan if you choose.
Boyd Rudy, associate broker with Dwellings Michigan, says other eligibility rules apply, too.
“You must be a U.S. citizen or permanent resident alien to qualify for a USDA loan. Also, you cannot have owned a home in the past three years,” he says.
Be aware that you won’t qualify for a USDA loan if you have been discharged from bankruptcy or if your home was foreclosed upon in the last 36 months, even if you have a credit score above 620.
“Also, being sent to collections or having a housing history with even a single 30-day late payment may disqualify you from the USDA home loan program,” warns Schwartz.
Loan limits apply to USDA loans. Currently, the maximum loan amount is the conforming loan limit (the limit set by Fannie Mae and Freddie Mac) for the home’s location. In many areas of the country, this max ceiling is $647,200 in 2022. But in areas with higher home prices, the loan limits are greater.
“For example, in Montgomery County in Maryland, the loan limit is $776,600,” Schwartz notes.
For more details on USDA loan limits, click here.
There are several reasons why a USDA loan might get rejected.
“One common reason is that the borrower fails to meet the income requirements. Another common reason is that the property is located in an ineligible area. And you may be denied if you have poor credit or inadequate collateral,” says Rudy.
Other common red flags that can get you turned down for a USDA loan include insufficient employment history, low credit score, a high DTI ratio, or a past bankruptcy.
Contrary to popular belief, a USDA loan can often be easier to qualify for than other types of mortgage loan financing.
“I’ve found that USDA-qualified buyers have very smooth transactions because the program is flexible and no down payment is required. A USDA loan can be one of the best ways for someone to get into their first home,” says Schwartz.
Solomon agrees.
“The best-kept secret in mortgage lending right now is the USDA loan. Those who learn about it immediately understand that it’s usually preferable to conventional loans or FHA loans,” he says.
If a USDA loan sounds enticing, make the effort to find out more about what is required and if you qualify. Shop around for a lender approved by the USDA to provide this loan. A bank, credit union, or mortgage broker in your area may offer this financing.
Also, consult with your real estate agent on how and when to apply for a USDA loan and if it’s worth considering alternative forms of financing, such as a conventional loan, FHA loan, or VA loan if you qualify.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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