When it comes to purchasing a home, navigating the complex world of mortgages can be overwhelming. For those seeking a path to homeownership with unique advantages, a USDA loan might be the solution.
The United States Department of Agriculture (USDA) offers a loan program specifically designed to assist individuals and families in rural areas in achieving homeownership. There are two main types of USDA loans: USDA direct and USDA guaranteed. USDA direct loans are issued by the USDA for low-income borrowers, and USDA guaranteed loans are offered by private lenders, like Neighbors Bank, and backed by the USDA.
Exploring the benefits of these programs is the first step in making an informed decision about whether a USDA loan is the right choice for you.
The Pros and Cons of USDA Loans
To better understand the benefits of USDA loans, it’s important to consider both the advantages and disadvantages of a USDA mortgage. See the chart below for an overview of the pros and cons of a USDA loan:
| Pros | Cons |
|---|---|
| No down payment | Income limits |
| Competitive interest rates | Property restrictions |
| Relaxed credit requirements | Occupancy requirements |
| No PMI requirement | USDA program fees |
| Penalty-free repayment | Longer underwriting timeline |
To see how USDA loans stack up against VA, FHA and conventional loans, read more about USDA loans compared to other loan options.
What Are the Benefits of a USDA Loan?
No Down Payment
One of the most significant benefits of USDA loans is that they do not require a down payment. This aspect is especially helpful for first-time homebuyers who may not have substantial savings for a traditional down payment. By eliminating this upfront cost, USDA loans open the door to homeownership for a broader range of individuals.
It's important to note that borrowers still have the option to make a down payment if they wish, which could potentially lead to lower monthly payments. However, the absence of a down payment requirement offers borrowers flexibility in how they allocate their funds.
Competitive Interest Rates
USDA loans come with a unique perk: the U.S. Department of Agriculture backs them. This partial government backing lowers the risk for lenders, letting them provide better interest rates for USDA loans than they can for other loan types. Over time, this can save you a lot of money and make owning a home more affordable.
Relaxed Credit Requirements
Unlike some other loan programs, USDA loans do not have a strict credit score requirement. While many USDA lenders may look for a minimum FICO credit score of around 640, borrowers falling below this threshold might still qualify for home financing. A borrower’s eligibility depends on a combination of other financial factors and if the lender perceives them as a risk.
At Neighbors Bank, we look for a minimum FICO credit score of 620.
No PMI Required
One of the exceptional benefits of USDA loans is that they do not require Private Mortgage Insurance (PMI). PMI is typically required on conventional loans when a borrower makes a down payment of less than 20%.
The reduced risk associated with these loans makes PMI unnecessary from a lender’s perspective. Eliminating the cost of PMI further reduces the monthly financial burden for USDA borrowers.
Penalty-Free Prepayment
Unlike many other loan options, USDA loans do not penalize borrowers for paying off their loans early. Paying off a mortgage early may be a smart financial move for some borrowers, as it reduces the amount you accumulate in interest over time. While other mortgage types come with prepayment penalties, USDA loans allow borrowers to pay down their mortgage faster with no negative financial consequences.
What Are the Disadvantages of a USDA Loan?
Income Limits
To qualify for a USDA loan, your household income must fall within 115% of the local median household income. While this restriction ensures that the USDA loan program targets those in need, it may limit eligibility for borrowers with higher incomes.
Property Restrictions
Properties must be located in a designated rural area to be eligible for USDA financing. Additionally, the home must meet USDA's minimum property requirements. These restrictions help direct the program's benefits to those seeking homes in less densely populated areas, but they can limit options for borrowers looking in more urban environments.
Note: Some property requirements may also vary slightly between direct and guaranteed loans, with direct loans typically having stricter eligibility criteria.
Occupancy Requirements
USDA loans come with specific occupancy requirements. For example, a home financed by a USDA loan must serve as the borrower's primary residence. Properties financed through this program cannot be second homes, vacation homes, or income-generating properties. Borrowers are also required to move into the home within 60 days of closing.
The USDA Guarantee Fee
While USDA loans do not require PMI, they do have their own program-related fees: the upfront guarantee fee and the annual fee.
The guarantee fee is currently 1% of the total loan amount, while the annual fee is 0.35% of the loan balance, which is rolled into the monthly payment. Despite these fees, USDA program costs are often lower than the expenses associated with private mortgage insurance or fees from other loan programs.
Note: These fees apply to guaranteed loans, which are backed by the USDA but issued by private lenders. Direct loans, offered directly by the USDA, have different fee structures and often include payment assistance, but are typically limited to very low-income borrowers.
Longer Underwriting Timeline
During the underwriting stage, lenders must verify additional factors such as a property location and income eligibility. Due to these factors, the USDA underwriting timeline may take slightly longer than other loan types.
Are USDA loans a good idea?
USDA loans can be a great option for homebuyers with limited savings, thanks to perks like no down payment and flexible credit requirements. However, they come with restrictions, such as income limits, property eligibility rules, and occupancy requirements, that can make qualifying more difficult. Whether a USDA loan is right for you depends on your finances, where you want to buy, and your ability to meet the program’s guidelines.
FAQs: Advantages and Disadvantages of USDA Loans
Here are some of the most frequently asked questions about the advantages and disadvantages of USDA loans.
What makes USDA loans more affordable than other types?
USDA loans often have lower monthly payments due to their competitive interest rates and the absence of private mortgage insurance (PMI). Instead, borrowers pay a modest annual fee, which typically costs less than PMI on conventional loans.
Is it true USDA loans don’t require a down payment?
Yes. One of the standout advantages of USDA loans is the $0 down payment requirement, which can be a game-changer for buyers without significant savings.
What are the biggest limitations of USDA loans?
The main drawbacks include income limits, geographic restrictions, and occupancy rules. These loans are intended for people buying primary residences in eligible rural or suburban areas and earning within a specific income range.
Do USDA loans take longer to process?
Yes. Because USDA loans involve an extra layer of approval from the USDA itself (in addition to lender underwriting), the processing time can be longer than for conventional or FHA loans.
Are USDA program fees better or worse than mortgage insurance?
Generally better. While USDA loans do have fees, like the upfront guarantee fee and annual fee, they are often more affordable than private mortgage insurance (PMI) on conventional loans or the mortgage insurance premium (MIP) on FHA loans.
Emily Kittle is an experienced underwriter with a strong background in risk assessment, training, and loan decision-making. She excels at solving complex mortgage challenges and guiding loans to closing using creativity and critical thinking.
