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Building a home can be a complicated process especially when it comes to financing it. A USDA construction loan is designed to simplify this process by bringing everything together under one loan. This zero-down, low-interest loan is a great option for low-to-moderate-income buyers looking to build a home in a rural area.
Let's explore how USDA construction loans work.
Please Note: Neighbors Bank does not offer USDA construction loans.
What Are USDA Construction Loans?
USDA construction-to-permanent loans, or USDA construction loans for short, are a type of one-time close mortgage guaranteed by the U.S. Department of Agriculture (USDA). These loans are part of the USDA's Single Family Housing Guaranteed Loan program, which aims to make homeownership more accessible for rural, low- or moderate-income homebuyers.
Although the majority of loans issued under the program are for existing single-family home purchases, the USDA construction loan is unique because it allows the buyer to finance the purchase of land and the cost of constructing a new home on it. Unlike many other construction loans, which require one loan for construction and another for buying the land, everything in a USDA construction loan is under one umbrella with one closing.
Because they're guaranteed by the USDA, these loans offer generous terms — often including no down payment requirement. That makes them a great option for some rural home buyers. The downside is that there are very few USDA construction loan lenders on the market right now.
USDA Construction Loan Requirements
Requirements for USDA construction loans are similar to those for other USDA loan types. Your total household income cannot exceed the USDA income limits for your local area. These generally start at $110,650 for a household of up to four, but they may be higher based on an area's cost of living.
Although the USDA doesn't have its own minimum credit score requirement, some lenders look for a score of at least 640. Other lenders, like Neighbors Bank, can go as low as 620, so it may help to shop around if your credit history is an issue. You'll also typically need a debt-to-income ratio at or below 41%. The amount you spend on housing, including property taxes, insurance and homeowner's association fees, can't be more than 29% of your income.
Property Requirements for USDA Loans
USDA loans also include more property restrictions than conventional loans. Because USDA building loans are aimed at helping homebuyers in rural areas, your construction project will have to fall within one of the USDA's designated rural areas. Additionally, the home must be your primary residence.
The USDA also stipulates that any construction you finance with one of its loans must fit the area. This typically means the home cannot exceed 2,000 square feet, but certain exceptions may apply.
Contractor Requirements for USDA Loans
A USDA new construction loan also has specific requirements for the contractors involved in the project. Any builders must be approved by your lender, have at least two years of experience with single-family home construction and be fully licensed for the work. They must also have a strong credit history, clean background check and minimum of $500,000 in liability insurance.
How Do USDA Single-Close Construction Loans Work?
One of the greatest benefits of a USDA construction-to-permanent loan is that it's a single-close mortgage. With many new-home construction projects, you'll have to go through the lending process twice — once for the construction loan and once to refinance that into a standard mortgage to purchase the final property.
With a USDA construction loan, you only need to apply for one loan and go through the entire process once. You'll pay only one set of closing costs, and when it's all said and done, you'll walk away with a USDA-backed 30-year mortgage on your new home. Along the way, you can use the loan to cover various construction-related expenses, from the initial land purchase to permitting, design and landscaping fees.
The downside of USDA loans is that they're more restrictive than conventional mortgages. Consequently, many buyers don't fit the strict income limits and location requirements needed to qualify for a USDA new construction loan. It also may be difficult to find a lender that offers this loan.
How to Get a USDA Construction Loan
Most importantly, before you get too far in the process, you'll need to locate a USDA-approved contractor along with a lender that will finance a USDA construction loan.
Once you've found both of those, you'll follow a similar process to what you would if you were applying for a standard USDA loan:
Get preapproved with your lender
Find land in a USDA-approved area
Sign a purchase agreement
Go through underwriting and get final approval
Sign and close on the loan
Begin construction on your new home
If you meet the basic USDA construction loan requirements, it's not too difficult to qualify for these single-close mortgages. Finding a lender and approved contractor are the hardest boxes to check, so once you've done those, you're well on your way.
With no down payment requirement and a seamless transition from a construction loan to a permanent loan, a USDA construction loan is a great way to finance your dream home — and to build it just how you imagined.
