Live in farm country or a rural outpost? A USDA mortgage may be right for you.
USDA mortgages, home loans insured by the U.S. Department of Agriculture, are designed to help people with low to moderate incomes buy homes in rural areas (generally in or near towns with a population of 35,000 or less). The income to qualify may be more flexible than you think -- in Santa Rosa, California, for example, a family of 5 would qualify with an income up to $125,050.)
A USDA loan can be an especially good option for a first-time homebuyer. The loans don't require a down payment or upfront closing costs. Plus, first-time homebuyers with scant or even damaged credit histories may still be eligible for USDA loans. In addition, the USDA offers a streamlined refinance program that requires no credit report or property inspections and appraisal.
The USDA single-family guaranteed loan does come with an upfront mortgage insurance fee that's equal to 1 percent of the total loan amount. For a $150,000 loan, for instance, the fee would be $1,500. It's a sizable amount, but it can be rolled into the mortgage instead of paid for out of pocket.
The other drawback is that USDA guaranteed loans charge 0.35 percent of the total loan amount annually in mortgage insurance fees over the course of the loan. That may not sound like much, but spread over only 12 months, you'll feel a bite. However, that's much less than the 0.4 to 0.5 percent USDA charged up to mid-2016.
The main qualifier is the home must be in a rural area, but that definition may be broader than you might think. Check for the USDA guidelines in your county. Even if your potential house is in the suburbs or close to a big city, you still might qualify.
The income requirements, too, vary from place to place. According to the USDA, nearly 80 percent of loans go to borrowers who aren't considered "low-income." You will need to show at least two years of consistent employment (or income) and a steady stream of on-time debt payments.
Popular USDA loans
The most popular USDA loan is the Section 502 Guaranteed Rural Housing Loan. Like FHA and VA loans, these loans are backed by the government via a mortgage insurance plan. Should you ever default, lenders rely on the USDA insurance to cover 90 percent of their losses.
Because these 30-year, fixed-rate loans are government-backed, lenders are encouraged to make loans to borrowers they might otherwise turn down. Participating lenders, such as national and local banks, complete the processing and funding of USDA guaranteed loans.
The USDA requires borrowers to pay for mortgage insurance. In addition to an initial fee of 1 percent of the purchase price, you'll also pay a monthly mortgage insurance premium of 0.35 percent of the loan's balance each year. Because your loan balance decreases every year, your monthly insurance payment will drop a bit each year.
The other popular USDA Section 502 loan is the Housing Direct Home Loan. With a direct loan, the USDA funds the loan itself through local USDA Rural Development offices. These loans are designed to help rural residents who have moderate or below-average household incomes.
Direct loans can be 33 or 38 years in length. The USDA offers assistance grants on direct loans to reduce the monthly payments to an effective interest rate as low as 1 percent.
Applying for the loan
A credit history with some dings may not rule out a USDA loans. If you have a low credit score or poor credit histories but can show you have worked diligently for a certain time, you may be able to eligible.
From the single father who has a low-paying job but has worked consistently for years, to the first-time homebuyer who lacks the money for a down payment, a USDA loan may be an ideal choice.
Because the USDA restricts the types of lenders allowed to offer the agency's loans, borrowers will need to do their homework to find an approved lender. Check with your local Rural Development office if you believe you qualify for a USDA direct loan.
Your application will include proof of income, federal income tax returns for the last two years, and other financial asset information. Once the lender has all necessary documentation, expect a credit check and a computation of your debt-to-income ratio. These steps will help determine if you qualify for a USDA loan, and if you do, the maximum amount you are eligible to borrow.
USDA loans typically take 35 to 40 days to close. The closing process starts after the homebuyer is determined eligible for the loan and a contract is signed. The lender will arrange an appraisal of the home, gather the title information and determine how the borrower will pay the 2 percent USDA fee.
After the underwriting and loan approval is completed, the file is sent to a USDA office for the final commitment. The lender and title agent will then meet to draw up the closing documents. Keep in mind snags can happen at any step, delaying the entire process.
If the USDA's automated process denies the application, the loan can still be manually underwritten, where an underwriter takes a closer look at whether the applicant has established a solid payment history with things like utilities or rent.
If you don't qualify for a USDA loan, you could potentially still get a mortgage from the Federal Housing Administration. Typically, the cost of an FHA loan is higher than USDA guaranteed loan costs. Each requires an upfront fee that can be rolled into the loan balance.
A USDA loan may not be the right choice for you. But as many happy homeowners can attest, it's well worth a look.
U.S. Department of Agriculture. https://www.rd.usda.gov/programs-services/single-family-housing-guaranteed-loan-program
Section 502 Guaranteed Rural Housing Loan. https://portal.hud.gov/hudportal/documents/huddoc?id=19565_502_GuaranteedLoa.pdf
Single Family Housing Direct Home Loans. https://www.rd.usda.gov/programs-services/single-family-housing-direct-home-loans