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USDA Direct vs. Guaranteed Loans: Navigating Your Homebuying Options in Rural America

By Neighbors Bank Team June 26, 2024

Understanding the different home loan options available can significantly impact your financial strategy, especially for those looking to settle in rural or suburban areas. Under Section 502 Single-Family Rural Housing Loans, there are two types of USDA loans: the USDA direct loan and the USDA guaranteed loan.

While both aim to enhance homeownership in less densely populated areas, they cater to different financial situations and offer distinct benefits and requirements. Before diving into these types of USDA loans, it’s essential to understand what they are and how they can benefit individuals and families looking to purchase property in rural areas.

Not sure if you're in a qualifying area? Check our property eligibility map!

The United States Department of Agriculture (USDA) developed both direct and guaranteed loan programs to provide affordable homeownership opportunities while promoting economic growth in rural communities. Both loan types aim to assist applicants who may not qualify for conventional loans due to income limits or other financial factors, making them ideal for individuals or families with fluctuating or non-traditional income sources.

As you explore the similarities and differences between these loan options, keep in mind that Neighbors Bank only offers USDA guaranteed loans. We do not finance USDA direct loans nor do other private lenders.

Quick Facts:

  • There are two different kinds of USDA loans: the direct loan and guaranteed loan.
  • The USDA direct loan is only available directly through the USDA and has specific requirements, making qualifying more difficult.
  • The USDA guaranteed loan is only available through private lenders, like Neighbor’s Bank, but it is still government-backed.
  • Both loan types have distinct advantages and disadvantages, but both direct and guaranteed loans offer potential homebuyers in rural areas a unique homebuying opportunity. Read more to find out which one is right for you!

What is a USDA direct loan?

USDA direct loans, also known as Section 502 direct loans, are only available directly through the United States Department of Agriculture (USDA). Borrowers must make no more than 50-80% of the area’s median income, which makes qualifying for this loan a little challenging if you don’t meet this criterion. In this borrowing scenario, the USDA serves as the lender and offers the funds necessary to purchase the property.

What is a USDA guaranteed loan?

USDA guaranteed loans, also known as Section 502 guaranteed loans, are available through private lenders, like Neighbors Bank, but are still backed by the USDA to mitigate potential risk for private lenders. Applicants cannot make more than 115% of the area's median income to be eligible. Because of its broader eligibility, this USDA loan option is often more favorable to borrowers and so more popular than USDA direct loans.

Comparing USDA Direct and Guaranteed Loans

While both direct and guaranteed USDA loans offer the benefits of a USDA-backed loan, like $0 down payments and lower interest rates, there are some key distinctions between the two. For a quick comparison of the USDA direct vs. guaranteed loans, consider the following aspects:

USDA Direct Loans USDA Guaranteed Loans
Credit score requirements No set credit score requirement No set requirement, but a 640 credit score is recommended
Income limits 50-80% of the area’s median income Up to 115% of the area’s median income
Property eligibility Must meet USDA minimum property requirements and be less than 2,000 square feet Must meet USDA minimum property requirements
Loan terms 33 or 38-year loan options depending on the borrower’s income level 30-year loan option
Interest rate Determined by government Fixed rate (based on borrower’s loan application)
Mortgage insurance Does not require private mortgage insurance Does not require private mortgage insurance, but borrowers pay an upfront guarantee fee and annual insurance premium

Income Considerations and Property Standards

For many families, the flexibility of the guaranteed loan can be appealing if they have higher income levels or require a larger home. Conversely, direct loans might be more suitable if you are looking for more substantial financial assistance and meet the stricter income criteria.

Both loan types require the property to be structurally sound, functionally adequate, and in good repair. This ensures that homes funded under these programs are safe and reliable for long-term residence.

Fees and Closing Costs

Both loans allow for rolling closing costs into the loan amount and potential seller contributions. Direct Loans do not require mortgage insurance, leading to lower monthly payments. However, guaranteed loans involve an upfront guarantee fee and an annual premium, comparable to other low-down-payment programs.

Application Process for USDA Direct vs. Guaranteed Loans

Applying for a USDA direct loan may be a little different from a USDA guaranteed loan since direct loans are only available through the USDA, so let’s take a closer look at the two application processes.

USDA Direct Loan Application

Unlike USDA guaranteed loans, there is no way to begin the USDA direct loan application process online. Applicants must apply for a USDA direct loan with their local Rural Development (RD) Office. These professionals will guide you through the application process and help you figure out if a USDA direct loan is the right fit for you. From there, the USDA works directly with the borrower throughout the loan process.

USDA Guaranteed Loan Application

When it comes to USDA guaranteed loans, applicants can submit their application to a USDA lender, like Neighbors Bank. These lenders work with the USDA throughout the loan process but are responsible for completing the loan application and underwriting process.

Pros and Cons of USDA Guaranteed Loans

Since direct loans are available directly through the USDA, Neighbors Bank only offers USDA guaranteed loans. If you’re looking to work with a lender throughout your homebuying journey, take a look below at the pros and cons of using a USDA guaranteed when compared to a USDA direct loan:

Pros Cons
Higher income limit Stricter credit score requirement
No maximum property size Only offers 30-year loan term
Work individually with USDA lender Additional fees (one-time 1% guarantee fee and 0.35% annual fee)

The Bottom Line

In conclusion, both types of USDA loans offer potential homebuyers in rural areas a unique homebuying opportunity. By understanding the differences and similarities between both USDA loan types, you can find one that is right for you!

Reach out to a Neighbors Bank’s loan specialist today to begin your homebuying journey!

Written by:
Neighbors Bank Team
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