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USDA Home Loan Program Pros and Cons

USDA Home Loan Program Pros and Cons
The USDA home loan program enables individuals with limited financial resources to buy homes located in rural communities with no down payment.  There are two types of USDA home loans: the guaranteed loan program and the direct loan program.  The guaranteed loan program, which is the most common type of USDA loan program, enables borrowers to obtain mortgages from USDA-approved lenders such as banks, mortgage brokers and credit unions.  With the guaranteed program the USDA insures 90% of the loan amount which protects lenders in the event the borrower fails to repay the loan.  With the direct loan program, borrowers receive a mortgage and possibly payment assistance directly from the USDA as opposed to from a lender.  The direct loan program is designed for individuals with low incomes who are not able to obtain a mortgage through other programs.  Benefits of the USDA home loan program include the ability to buy a home with no money down, a lower interest rate as compared to other mortgage programs and lower mortgage insurance costs.  Disadvantages of the USDA program include that the property must be located in a USDA-designated rural area, more conservative borrower qualification requirements and borrower income limits.  Review the full list of the pros and cons for the USDA home loan program below.

USDA Home Loan Program Pros

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No Down Payment Required

The USDA home loan program enables eligible applicants to buy a home located in a USDA-designated rural area with no down payment.  Saving money for a down payment can be one of the biggest challenges to buying a home, especially for people with low-to-moderate incomes.  By enabling borrowers to finance 100% of the purchase price of a home, the USDA program makes home ownership more affordable for people living in rural communities. 

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Low Interest Rate

The mortgage rate on a USDA home loan is typically lower than the interest rate for most low or no down payment programs including the FHA mortgage program.  The interest rate for a USDA mortgage is lower because the loan is insured by the USDA and borrowers are required to pay up-front and ongoing USDA mortgage insurance fees, which are also called guarantee fees.  The USDA backing and insurance essentially guarantee that the lender will recover the full amount of the loan in event the borrower defaults on the mortgage.   The lower interest rate on an USDA mortgage reduces your monthly mortgage payment and potentially saves you thousands of dollars in total interest expense over the life of the loan.  Borrowers should shop lenders to find the USDA mortgage with the lowest interest rate and fees.

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Lower Mortgage Insurance Fees

The USDA home loan program requires borrowers to pay up-front and ongoing monthly mortgage insurance fees but the fees are lower than for many other low or no down payment mortgage programs.  As of October 1, 2016, the up-front USDA mortgage insurance fee is 1.0% of the mortgage amount and the monthly mortgage insurance fee is .35% of the mortgage amount.  In comparison, for an FHA loan the up-front mortgage insurance premium is 1.75% of the loan amount and the monthly mortgage insurance premium ranges from .80% to 1.05% of the loan amount for a 30 year mortgage.  Additionally, for most borrowers the monthly USDA mortgage insurance fee is usually less than what monthly private mortgage insurance (PMI) would be for a similar mortgage (most conventional mortgages require borrowers to pay private mortgage insurance (PMI) if you make a down payment of less than 20% of the property purchase price).  The one negative of USDA mortgage insurance as compared to private mortgage insurance (PMI) is that you are required to pay monthly USDA mortgage insurance for the life of your loan whereas PMI is removed when your loan-to-value (LTV) ratio reaches 78%.

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No Loan Limits

Unlike many low or no down payment mortgage programs, the USDA home loan program does not apply loan limits that restrict the size of mortgage borrowers can obtain.  For example, both the FHA and VA mortgage programs use loan limits.  The USDA home loan program does use borrower income limits but not having loan limits makes the program accessible to more people and potentially enables you to buy a nicer home.

USDA Home Loan Program Cons

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Property Eligibility Requirements

The USDA home loan program applies several property eligibility guidelines that reduce the number of borrowers who can use the program.  The property being financed with a USDA loan must be located in a USDA-designated rural area or small community.  USDA-designated rural areas comprise approximately 95% of the land in the United States representing over 100 million people.  Most homes, however, are located in major cities which means they not eligible for the program.  You can use the USDA's property eligibility tool to determine if a property is located in USDA-designated rural area.  Other USDA program eligibility requirements include that the property must be a single-family primary residence such as a home or condominium that is in good condition.  Unlike some other low or no down payment programs, multi-family properties are not eligible for the USDA program.  Borrowers should make sure that the property they want to buy is eligible for the USDA home loan program before moving forward with the mortgage application process.

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Stricter Borrower Qualification Requirements

The USDA home loan program uses somewhat more conservative borrower qualification requirements as compared to other low or no down payment mortgage programs.  To qualify for a USDA home loan, borrowers are typically required to have a minimum credit score of 620 as compared to the 580 minimum credit score required for the FHA mortgage program.  Additionally, the USDA program applies a borrower debt-to-income ratio of 41% to determine what size mortgage you can afford as compared to the 43% - 50% or higher debt-to-income ratios used by the FHA and other programs.  The debt-to-income ratio represents the maximum percentage of a borrower's monthly gross income that can be spent on total monthly housing expense (mortgage payment plus property taxes, homeowners and mortgage insurance) plus other monthly debt such as credit card, student and auto loans.  The lower the debt-to-income ratio used, the smaller the mortgage you qualify for.  The USDA program does permit a higher debt-to-income ratio for borrowers with higher credit scores and stronger financial profiles.

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Borrower Income Limits

The USDA home loan program applies a maximum gross income limit to how much money borrowers can make.  Borrowers who earn more than the income limit are not eligible for the program which means many borrower cannot use the USDA program, even if they live in a USDA-designated rural area .  USDA borrower income limits vary by county and by the number of people in the borrower's household with the larger the household, the higher the limit.  The income limit for the USDA guaranteed home loan program is typically 115% of the median household income for the area in which the property is located.  The income limit for the USDA direct loan program is typically 50% - 80% of the median household income for the area.  You can review USDA home loan program income limits for your county on the USDA web site.

More FREEandCLEAR Resources

Mortgage Guides

USDA Home Loan Program Overview

Review our comprehensive overview of the USDA home loan program including property eligibility guidelines as well as borrower qualification requirements and income limits.

Mortgage Calculators

USDA Home Loan Qualification Calculator

Use our USDA Home Loan Qualification Calculator to determine what size USDA loan you can afford based on your monthly gross income and debt.  The calculator also provides the up-front and ongoing monthly USDA mortgage insurance fees (guarantee fees) based on your mortgage amount.

Resources

Mortgage Rates

USDA guaranteed mortgages are provided by traditional lenders such as banks, mortgage banks, mortgage brokers and credit unions.  Use our mortgage rate table to review updated mortgage rates and fees for lenders in your area.  Comparing rates from multiple USDA home loan program lenders is the best way to save money on your mortgage.

Programs

Comparison of Low or No Down Payment Mortgage Programs

Review and compare multiple government-backed and conventional low or no down payment mortgage programs to understand key program benefits and borrower eligibility requirements.

Resources

FREEandCLEAR Lender Directory

Use the FREEandCLEAR Lender Directory to find lenders that offer the USDA mortgage program

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