USDA loans: What are they and am I eligible?

USDA loans are a unique sort of mortgage. Aimed at encouraging homeownership in specific sections of the U.S., they offer some generous terms — but also some limitations, catering to a pretty specific sort of buyer.

Let’s explore what USDA loans are, their benefits and drawbacks, and who is eligible for them.

What is a USDA loan?

A USDA home loan is a type of government-backed mortgage, available to low- and moderate-income homebuyers in largely rural areas. Also referred to as rural development or RD loans, they are part of a national program created by the U.S. Department of Agriculture to help create loans for first-time homebuyers or people who don’t meet conventional mortgage requirements.

USDA loans cater to this clientele in several ways. They are a no-down payment mortgage — you don’t have to bring any cash to the purchase, but can finance it completely. Along with no need for a down payment, USDA loans have another advantage: You could qualify for a modest, fixed interest rate if you have low income.

Some drawbacks, though, are that the property must be located in a USDA-approved area, and borrowers cannot earn more than a certain amount.

Who is eligible for a USDA loan?

USDA eligibility requirements include:

• The borrower must be a U.S. citizen or permanent resident with a track record of stable income.
• The home must be in a rural area designated by the USDA.
• The borrower’s household income must be limited to 115 percent of the median income in the county where the property is located.
• While USDA loans have no formal minimum credit score, a borrower must have a credit history that demonstrates they can pay back debt. To qualify for streamlined processing, the minimum score is 640. The USDA uses alternative methods to evaluate borrowers without credit scores.

Eligible properties

The easiest way to find out if a home is in a USDA-eligible area is to check the USDA website. Homes purchased with USDA loans must be located in eligible rural areas. The USDA defines these areas as “open country or any town, village, city, or place, including the immediately adjacent densely settled area, which is not part of or associated with an urban area.”

USDA mortgages are only available in these rural areas as part of a government initiative to promote homeownership and economic growth. These loans can help attract and retain people in these locations.

Income limits

The USDA guaranteed loan program is geared toward low- and moderate-income homebuyers. For this reason, applicants can’t earn more than certain income limits, which vary by metro area and family size. In more expensive areas, the income ceiling is higher: Sometimes you can earn as much as six figures. You can check income limits for your county and household size using the same property eligibility tool on the USDA website.

To prove income, you’ll need to provide the lender with documentation such as:

• Paystubs
• Tax statements (W-2s, 1040s and 1099s)
• Alimony and child support payments
• Social Security payments
• Statements for bank and investment accounts

Credit score

The USDA doesn’t impose a blanket credit score requirement for all borrowers, but typically, USDA-approved lenders look for a score of at least 640.

Types of USDA loans

Different types of USDA loans cater to different buyers, each with its own requirements and reasons for use.

USDA guaranteed loans

The USDA guaranteed home loan program (officially known as Section 502 Guaranteed) allows approved mortgage lenders to provide 30-year fixed-rate loans to borrowers in USDA-eligible locations. It’s called a “guaranteed loan” because the USDA guarantees to reimburse up to 90 percent of the loan to the lenders in the event the borrower were to default on the mortgage.

Along with buying a home in a USDA-approved area, you’ll also need to meet an income requirement: no more than 115 percent of your area’s median household income (AMI). You can find income limits for your market using this tool.

USDA direct loans

Also known as Section 502 Direct, USDA direct loans offer low-rate home loans to individuals in rural areas in need of adequate housing. Unlike USDA guaranteed loans, you’ll apply for a direct loan through the USDA’s Rural Development Service Centers — not through a lender.

Direct loans are only available to households with low and very low income — you can view income limits here — and they must “be unable to obtain a loan from other resources,” according to the USDA. There’s also a limit on how much you can borrow — ranging from $398,600 to $919,800, depending on the county where the home is located. (You can view area loan limits here.)

Direct loans have a fixed interest rate, currently 4.75 percent, which can be reduced to 1 percent if you qualify for payment assistance. The loan terms range up to 33 years, or 38 years for very low income borrowers.

USDA repair loans and grants

The USDA repair loan program (Section 504 Home Repair) is similar to the direct program in that it caters to low-income individuals. But it’s different in that it provides loans only up to $40,000 and only to help improve or fix a home — it’s not intended for purchasing a place. The program also offers grants to very low-income homeowners aged 62 or older to help remove hazards in the residence; these are capped at $10,000.

Pros and cons of USDA loans

The major benefit of a USDA home loan is that it’ll cover the total cost of a home purchase, without mandating a contribution from the borrower. This can be a great boon for cash-strapped homebuyers. The drawbacks mostly have to do with the restrictions on where you can buy or how much income your family can have.

Pros

• No down payment required
• No formal loan limit for guaranteed loans
• Seller can pay the closing costs
• Available for both purchasing and refinancing
• Low, fixed interest rates for direct loans

Cons

• Property must be in designated locales
• Must use the home for a primary residence
• Buyer’s income can’t exceed a certain amount
• Upfront and annual fees
• Loan size can be limited (direct loans)

Should you get a USDA loan?

If your income and prospective properties qualify you for a USDA loan, you will definitely want to explore the option. USDA guaranteed loan interest rates are competitive with other mortgage rates. And of course, the no-down-payment feature is highly tempting.

The “cons” of this loan type are largely on the front end – limiting who is eligible to borrow and for what kind of property. The best deal, the direct loan, is pretty limited in terms of who qualifies. And then of course, there’s the extra paperwork and lengthy approval process that often accompany government-guaranteed mortgages.

How to apply for a USDA loan

To apply for a USDA loan, you’ll first need to determine if you qualify. Consult the USDA property and income eligibility maps. If you meet those parameters, next consider whether you’ll want or need a guaranteed or direct loan.

Remember: Guaranteed loans have stringent income limits, and you’ll apply for one through a USDA-approved lender. Direct loans, on the other hand, are reserved for lower-income borrowers who lack access to safe housing or other financing sources, and obtained directly through the USDA.

When you’re ready to apply, you’ll submit paperwork about your finances, including income, assets and debt, and undergo a credit check. If preapproved, you can begin searching for a home in an appropriate area.

USDA loan fees

USDA mortgages come with two fees:

• Upfront guarantee fee: The upfront guarantee fee this fiscal year is 1 percent of the loan amount. For example, for a $100,000 loan, this fee would be $1,000. This fee can often be rolled into the mortgage instead of paying it out of pocket.
• Annual fee: The annual fee is 0.35 percent of the loan amount. A $100,000 mortgage, for example, would have a $1,000 one-time payment (the upfront guarantee fee) and a $350 per year ongoing payment for the life of the loan.

Both of these fees are charged to the lender, who then usually passes the cost on to the borrower. These fees keep USDA loans subsidy-neutral, which means that any losses incurred by the program are paid for by these fees instead of taxpayer dollars. Depending on the needs of the program, the fees can change annually.

How much does it cost to get a USDA loan?

Along with the two USDA fees listed above, you’ll need to cover regular mortgage costs. These may include:

• Origination fee: Many lenders charge an origination fee on mortgages, regardless of loan type. The fee usually costs around 1 percent of the amount you’re borrowing.
• Loan application fee: Some lenders charge a nominal fee to complete the mortgage application.
• Title insurance and services: When you buy a home with a mortgage, you’ll need to pay for a title search and lender’s title insurance policy. The cost varies depending on the closing attorney or settlement or title company you work with.
• Processing or underwriting fees: In addition to (or sometimes in lieu of) an origination fee, some lenders charge a “processing” or “underwriting” fee. This cost covers the expense of underwriting your loan application.
• Credit report fee: Many lenders charge a small fee to run a credit check.
• Appraisal: As the homebuyer, you’ll be responsible for paying for the home appraisal before the lender can approve your loan. A home appraisal cost a median of $500 in 2023, according to the National Association of Realtors.
• Discount points: Many lenders offer the option to purchase mortgage points to buy down your loan’s interest rate. One point costs 1 percent of the amount you’re borrowing.

USDA loan rates

As of June 1, 2024, the current rate for a USDA Single Family Housing Direct Loan is 4.75 percent for borrowers who qualify. This is well below the national average for a conventional 30-year mortgage loan, which hovers around 7 percent at the time of this writing.

The USDA guaranteed loans, which more people will qualify for, have rates more akin to standard interest rates. Still, they’re competitive, and sometimes even run as much as 75 basis points lower. A lot depends on the lender, so shop around.

While mortgage points may be one way of bringing down the rate on a conventional mortgage loan, the USDA loan rate remains highly competitive in today’s market.

How do USDA loans compare to other types of loans?

USDA loans aren’t the only type of mortgage out there. If you’re not eligible for a USDA loan, you might be for an FHA or VA loan, or even a conventional loan. Here’s an overview of some key differences between these types of loans:

USDA loan FAQ

• Do USDA loans require private mortgage insurance (PMI)?

  USDA loans do not require PMI: That’s only for borrowers of conventional loans who put down less than 20 percent. Nor do they require the sort of mortgage insurance premiums FHA loans charge. Instead, USDA loans charge two fees: the upfront guarantee fee (which equals 1 percent of the loan amount) and an annual fee (which equals 0.35 percent of the loan amount, charged yearly).

• Can I use a USDA loan to refinance an existing mortgage?

  You can refinance an existing USDA mortgage into another USDA mortgage or refinance an existing USDA mortgage into a conventional mortgage. However, you cannot refinance a non-USDA mortgage into a USDA mortgage. If you have a USDA loan, you have three options for refinance: a USDA streamline, USDA non-streamline or conventional loan refinance.

Additional reporting by Meaghan Hunt