USDA Home Loan: Is This Your Right Mortgage Choice?
You decided to finally buy your first home. Good choice.
A lot goes into the decision.
You want to find the ideal home in a good neighborhood. It should fit your budget and possess the right amenities.
Once you have found the property, you have another important decision to make: how you will finance it.
Today’s market offers a number of programs that make buying your first home easier. And there’s no “right” loan choice for everyone. The correct loan is the one that suits your situation the best.
Two popular options are the USDA Rural Development loan and the FHA home loan.
They are both low-downpayment loans, but beyond that, they are very different. You might be surprised at which one is the right choice for you.
4 Ways USDA (Or FHA) Might Be Better
What if you could get a no-downpayment loan with comparable mortgage rates to FHA? And, what if that loan allows you to finance closing costs, even without ultra-high credit scores?
Is such a loan too good to be true? Hardly.
The loan actually does exist, and it is called the U.S. Department of Agriculture (USDA) Rural Development home loan. It is rising in popularity among first-time home buyers.
A USDA home loan is different from a traditional mortgage in several ways. But that doesn’t make them inaccessible. In fact, some features of USDA make them more attainable compared to FHA.
1. Zero-down financing, plus more
USDA loans require no downpayment. You may finance up to 100% of the property value, which, sometimes, is above the home’s purchase price. In these cases, the buyer can finance closing costs.
Here’s how it works. You make an offer on a home for $200,000. The lender’s official appraisal report states the home is worth $205,000.
The buyer can open a loan for the full value, as long as the excess funds are applied to closing costs such as the title report and loan origination fees.
Excess funds can even be used to prepay property taxes and homeowner’s insurance.
So, in the end, the buyer pays even less than “no-downpayment.”
Home buyers typically pay something out-of-pocket, even if they put nothing down. Closing costs can add thousands of dollars to the necessary cash-to-close figure.
Even most renters must put up a security deposit, plus a few months’ rent.
But with USDA, there’s a chance the buyer can walk into a home paying nothing from their own bank account.
With FHA, the home buyer must come up with a 3.5 percent downpayment, plus closing costs. FHA has no guideline stating that the loan amount can exceed the purchase price.
The only way to get a zero out-of-pocket loan with FHA is to get a downpayment gift, plus additional gift funds or seller contributions for closing costs.
USDA is more flexible, so buyers with little cash on-hand should look into this option first.
2. USDA’s “rural” location requirement
USDA eligibility depends on the location of the home. You must purchase a property in a rural area as defined by the USDA.
But the definition of “rural” is quite liberal, and based on U.S. census information from more than 15 years ago. So, many solidly suburban areas are still eligible.
USDA publishes online maps with which buyers can check the eligibility of a certain address or geographical area. Buyers will find that some entire states are USDA-eligible. Even highly populated states contain surprisingly vast USDA-eligible areas.
An estimated 97% of the American landscape is geographically eligible for a USDA loan.
Still, some buyers might find that eligible areas are too far outside employment centers, and for that reason choose an FHA loan, which comes with no geographical restrictions.
3. USDA income limits
The Rural Development loan was created to spur homeownership in rural areas, especially among home buyers who would not otherwise qualify.
As such, USDA publishes income limits. Maximums are set at 115% of the median income for the county or area. That amounts to fairly non-restrictive limits. The following are examples of maximum annual incomes in various locales around the country.
- Denver, Colorado: $94,600
- Portland, Oregon: $84,550
- Philadelphia, Pennsylvania: $93,750
- Albany County, Wyoming: $85,700
Not everyone will fall within USDA income limits. That’s where FHA comes in. FHA loans come with absolutely no income limits for its standard program.
4. The “owner-occupied” rule
You do not have to be a first-time home buyer for either FHA or USDA. However, for both loan types, you can’t own adequate housing within a reasonable distance of the home being purchased.
For instance, if you own a three-bedroom house, you can’t use FHA or USDA to buy another three-bedroom house down the street.
You must also plan to live in the home you buy. Rental and investment housing is not allowed under USDA or FHA. Both loans have the same goal: get individuals and families into their own homes.
Neither loan permits activity that could be interpreted as a real estate investor building a portfolio.
USDA And FHA Mortgage Insurance Premiums
Similar to the Federal Housing Administration’s FHA mortgage, the USDA uses homeowner-paid mortgage insurance premiums to keep the USDA home loan program viable for future home buyers.
But USDA mortgage insurance premiums are cheaper than those of FHA, and have recently dropped even further.
Beginning in October 1, 2016 USDA reduced its mortgage insurance premiums.
The upfront mortgage insurance, which is financed onto your loan balance, dropped from 2.75 percent to 1.0 percent. Likewise, the monthly premium fell 15 basis points (0.15%) to just 0.35 percent.
Compare USDA mortgage insurance to that of FHA and you will immediately see the significant savings.
The FHA upfront mortgage insurance premium is 1.75 percent and the monthly fee is typically 0.85 percent of the loan balance, divided equally into twelve installments and included with each mortgage payment.
USDA Loans vs FHA: Ease Of Qualifying
There is no stated maximum loan size for the USDA loan program. The amount you can borrow, rather, is limited by your household’s debt-to-income (DTI) ratio, the comparison between your monthly debt payments and gross income.
For instance, a home buyer who makes $6,000 per month and $2,000 in monthly debt payments has a DTI of 33 percent.
The USDA typically limits debt-to-income ratios to 41%, except when the borrower has a credit score over 660, stable employment, or can show a demonstrated ability to save.
These mortgage application strengths listed above are often referred to as “compensating factors” and can play a big role in getting approved for any mortgage — not just USDA.
Both FHA and USDA mortgage options have pros and cons:
- No downpayment: USDA loans only; FHA is 3.5 percent
- Location freedom: FHA primarily; USDA is restricted
- Income limitation: USDA only; FHA has no caps
- Mortgage Insurance Premiums: USDA is cheaper
- Rebound buyers: FHA is more flexible after foreclosure
In most cases, home buyers that qualify for a USDA rural home loan should go in that direction.
With comparable rates, lower mortgage insurance premiums and the option for 100 percent financing, USDA Rural Development loans make sense for many of today’s suburban home buyer.