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What Is a USDA Loan?

With home prices on the rise, the dream of homeownership might seem less and less attainable. Depending on where you're buying, however, you may find that you have more options than you originally thought. If you're moving to a rural or suburban area, a loan through the U.S. Department of Agriculture (USDA) may be a good choice.

A USDA loan is a low interest, no down payment mortgage loan available to eligible suburban and rural homebuyers. Read on to learn how it works and see if it's the right option for you.

How Does a USDA Loan Work?

The USDA's Rural Development Guaranteed Housing Loan Program offers loans to help low- to moderate-income consumers buy a home. To qualify for a USDA loan, an applicant must be looking to buy a home in an eligible rural or suburban area and meet certain income requirements. Dense urban areas are excluded, but that leaves 97% of the geographical U.S. as eligible for USDA home financing.

What Are the Types of USDA Loans?

There are three types of USDA loans. They include:

  • Section 502 Direct Loans: This type of USDA mortgage loan is available to low- and very-low-income borrowers. The current interest rate for direct home loans is 3.125% but can be a low as 1% when modified by payment assistance (a subsidy that temporarily reduces mortgage payments). The home you wish to finance using this program must meet certain requirements, including cost. Because home values vary widely by geography, each county has its own price limit for direct loans.

To find a USDA direct loan, browse the list of state offices that are a part of the USDA Office of Rural Development.

  • USDA Housing Repair Loans and Grants (also known as the Section 504 Home Repair Program): The Section 504 Home Repair Program loans funds to homeowners who wish to repair or upgrade their homes. This program offers loans up to $20,000 with a fixed interest rate of 1%. Elderly applicants who want to make their homes safer are eligible for additional grants of up to $7,500 for a total of up to $27,500 in assistance.

If you're interested in a repair loan or grant, contact a Rural Development office in your area to apply.

  • USDA Guaranteed Loans: Through this program, borrowers can obtain loans from USDA-approved lenders and take advantage of some of the lowest mortgage interest rates. The program's 90% loan guarantee reduces risk to the lender and makes it possible to obtain a loan without a down payment, even absent an excellent credit score. With this type of loan, you'll be required to pay a mortgage insurance premium if you don't put any money down.

To get this type of loan, you'll need to work with a USDA-approved lender. While many lenders offer USDA loans, it's best to work with one that specializes in this type of mortgage.

What Is the Difference Between an FHA Loan and a USDA Loan?

An FHA loan is a loan insured by the U.S. government's Federal Housing Administration. It's a popular type of mortgage that's often chosen by first-time homebuyers for its low down payment and credit score requirements. Some FHA lenders work with scores as low as 500, provided that the applicant agrees to put 10% down. Those with credit scores at or above 580 can put down as little as 3.5%.

With FHA loans, there are no location limitations. Buyers can choose a home anywhere in the U.S., including urban areas. If you're looking for a home in a big city, you'll most likely choose an FHA loan over a USDA one if you qualify.

While an FHA mortgage is easier to qualify for, a USDA loan can save you more money. Not only can you get a home with no money down, but you'll also be able to save on costs and fees. For instance, upfront mortgage insurance on an FHA loan is 1.75% compared with 1% on a USDA loan. The interest rates on FHA loans are also considerably higher. Depending on the term of the loan, FHA borrowers can expect to pay around 4% in interest.

Overall, a USDA loan might be a better choice financially, but since it has stricter eligibility requirements, an FHA can be a good alternative option.

Who Is Eligible for USDA Home Loans?

You can apply for a USDA loan if you meet the following requirements:

  • You are a U.S. citizen or permanent resident.
  • You can prove your creditworthiness.
  • You can show stable and dependent income.
  • You are willing to repay the mortgage as agreed.
  • You meet income requirements.
  • For USDA direct loans, the property you're intending to buy must be under 2,000 square feet in size.
  • The property holds a market value below the area loan limit and is in an eligible area.
  • You intend to use the property as your primary residence.
  • You don't own another home.

What Credit Score Do I Need to Get a USDA Mortgage?

While the USDA doesn't have a set credit score requirement, most lenders offering USDA-guaranteed mortgages require a score of at least 640. This is the minimum credit score you'll need to be eligible for automatic approval through the USDA's automated underwriting system.

It's also possible to qualify for a USDA mortgage with a score below 640. In this case, your lender will use manual underwriting, which can make the process longer.

If you don't have a credit history, your lender may ask you to provide at least 12 months of proof you pay your bills on time. This can include rent, car lease, insurance, school tuition, utility and other bills that can demonstrate your financial responsibilities.

The Bottom Line

The requirements for a USDA loan can be pretty strict, but it gives many people who otherwise wouldn't be able to afford a mortgage an opportunity to become homeowners. If you'd like to live in a rural or suburban area and think you'll qualify, consider a USDA mortgage loan.

If you're ready to start preparing for a mortgage, check your free credit score to see where you stand and what you can improve before you turn in your mortgage application.

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