What Is a USDA Loan?

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 homes. To qualify, applicants must be looking to finance a home in an eligible rural or suburban area. The home must be intended for use as their primary residence and the homebuyer's income must fall below specific limits, which depend on local median income levels.

Densely populated urban areas of the country are excluded from the program, but that leaves 97% of the geographical U.S. as eligible for USDA home financing. The USDA's Single Family Housing Direct Self-Assessment tool can help you determine your eligibility in the area where you wish to finance a home.

Types of USDA Loans

There are three types of USDA loans:

Section 502 Direct Loans

This type of USDA mortgage loan is available to low- and very-low-income borrowers. Loan proceeds may be used to purchase, renovate or relocate a home, or to make site improvements including installation of water and sewage services.

The current interest rate for direct home loans is 2.5%, but rates can drop as low as 1% when modified by payment assistance—a subsidy that temporarily reduces mortgage payments. Loan repayment periods are typically no longer than 33 years, but 38-year loans are available to recipients who cannot afford monthly payments on a 33-year loan.

The home you wish to finance using Section 502 direct loans must meet certain requirements, including cost. Because home values vary widely by geography, each county has its own price limit for purchases made using Section 502 loans.

Single Family Housing Repair Loans & Grants

Also known as the Section 504 Home Repair Program, this USDA initiative lends funds to homeowners who wish to repair or upgrade their homes. The program is available to applicants with incomes that fall below 50% of the local median income who cannot get affordable credit elsewhere, to fund improvements on homes they occupy (no rental properties or vacation homes).

Single Family Housing Repair Loans offer financing of up to $20,000 at a fixed interest rate of 1%, to be repaid over a period of up to 20 years.

Single Family Housing Repair Grants allow applicants aged 62 or older who cannot afford home improvement loans to receive as much as $7,500 for projects that make their homes safer. Individuals can apply for multiple grants over time, but the total lifetime grant amount cannot exceed $7,500. The grant must be repaid if the property is sold within three years of the grant being issued.

Homeowners who can afford to make partial, but not full, repayment on Section 504 loans are eligible to apply for a combination of grants and loans to fund qualified home improvement projects, for total funding of up to $27,500.

The USDA Single Family Housing Section 504 Repair Pilot Program is offering qualified applicants even higher loan and grant amounts in rural areas of California, Hawaii, Illinois, Indiana, Iowa, Kentucky, Maine, Michigan, Mississippi, New Jersey, New Mexico, New York, North Carolina, Oregon, Pennsylvania, Puerto Rico, South Carolina, Texas, Tennessee, Virginia, Washington and West Virginia.

To learn more about USDA Single Family Housing Repair Loans and Grants and to apply for them, contact your regional Rural Development office.

USDA Guaranteed Loans

A contrast to the direct loans issued by the USDA itself, USDA Guaranteed Loans are issued through USDA-approved lenders, including banks and credit unions. The Guaranteed Loan program promises lenders it will cover 90% of any loan issued under its guidelines if the borrower fails to repay the loan. That enables lenders to offer low-interest loans to borrowers who don't have a down payment and have a less-than-ideal credit score. With this type of loan, the buyer will be required to pay a type of mortgage insurance fee called a guarantee fee if they 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.

How to Qualify for a USDA Loan

You are eligible to apply for a USDA loan if you meet the following requirements:

• You are a U.S. citizen or permanent resident.
• The property you wish to buy or renovate is located in an eligible rural or suburban area; its market value falls below designated limits for the area; and it will serve as your primary residence.
• You can show stable, dependable income sufficient to make the loan payments.
• Your income is sufficiently below local median income for your area and meets specific requirements dependent on the loan type and local median income.
• For USDA direct loans, the property you're intending to buy must be under 2,000 square feet in area.
• You don't own another home.

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

The USDA doesn't have a fixed credit score requirement, but most lenders offering USDA-guaranteed mortgages require a score of at least 640, and 640 is the minimum credit score you'll need to qualify for automatic approval through the USDA's automated loan underwriting system. Before you submit any loan applications, take a look at your credit reports and scores to see where you stand. You can get your credit report from all three credit bureaus (Experian, TransUnion and Equifax) for free through AnnualCreditReport.com. Your Experian credit report and credit score based on Experian data are also available for free.

If your credit score is below 640, or if you have no established credit history (and therefore cannot generate a credit score), you could still qualify for a USDA mortgage if the lender gauges your creditworthiness through a process known as manual underwriting. This typically requires an examination of your financial records, including evidence of at least 12 months of timely bill payments. Manual underwriting takes longer than automated underwriting and can still result in your loan application being declined. You also have the option of taking the opportunity to improve your credit.

If you have steady but limited income and are interested in buying or making improvements to a home in a rural or suburban area, a USDA loan could be a great vehicle for getting you set up in a house of your own.