How Do USDA Loans Work?
A USDA loan is one that follows established guidelines set forth by the United States Department of Agriculture and designed to help those who want to buy and finance an owner-occupied residential property located in a rural or semi-rural area. The program has changed its name over the years and when first introduced in 1935, it was known as the Resettlement Administration. For families that were victims of the Great Depression, the Resettlement program provided financial assistance to those in need to buy/finance a home and transfer families in depressed areas into more stable economic environments.
Today, the USDA loan is used to finance a home in preapproved areas the Census Bureau has defined as “rural.” Technically a USDA loan cannot be used in urban and suburban areas but you would be surprised to find that the predesignated zones can be found in suburbs and neighborhoods surrounding city limits. Buyers who wish to explore a USDA loan must find a property or an area of interest and give that address to the loan officer who can then research the property to see if it’s in an eligible zone.
Obtaining financing in rural areas where there are very few homes and sparse populations can be difficult for traditional conventional financing. The USDA loan program is specifically designed to fill this niche.
What are the USDA Loan Requirements?
USDA loan requirements are much like any other government-backed mortgage programs. The other two government-backed home loan programs are VA and FHA loans and are referred to as government-backed because the lender is guaranteed compensation should the loan ever go into default.
USDA loans can only be used to finance an owner-occupied property and cannot be used to finance a rental or investment property. There are also income limitations for each household. Any person 18 years and older living in the property is counted toward qualifying income. This limit is at 115 percent of the median income for the area. This income calculation is based upon where the property is located, specifically which county the property resides and the size of your household.
Don’t worry you don’t have to calculate the income on your own, that is what we are here for. We are also able to give income deductions for various things. Give us a call or complete our online application and we can calculate the income limit for the county you are looking to purchase in.
What are the Benefits with a USDA Loan?
Perhaps the most popular feature is there is no down payment needed in order to qualify for a USDA loan. That’s a significant cost-saving benefit that few other programs can provide. The only other zero-down loan is the VA loan but this is limited to certain members and veterans of the military.
Lenders are also provided a guarantee should the loan ever go into default. This means borrowers who are having trouble qualifying for a low down payment mortgage may indeed obtain an approval with a USDA loan, knowing that the lender will be compensated for the loss in the instance of a default.
This guarantee is financed by two separate forms of mortgage insurance. The Upfront Guarantee Fee is 1.0% of the loan amount and is financed directly into the final loan. An annual guarantee fee of 0.35% which is calculated each year based upon the outstanding loan balance and is paid in monthly installments. The USDA annual fee of 0.35% is lower than the FHA annual fee of 0.85%.
There are no loan limits with the USDA program. Instead, lenders qualify borrowers based upon household income and monthly credit obligations. Further, sellers can pay for the buyers closing costs up to 6% of the sales price. Closing costs can include origination fees, processing fees, title fee, property taxes and insurance escrow or impound accounts.
The USDA loan is issued as a 30 year fixed rate loan. There will be no adjustments during the life of the loan and borrowers are more easily able to plan for their financial future knowing the principal and interest payment will never change.
What are the USDA Loan Limits?
There are no loan limits with the USDA loan program. Conventional loans, jumbo, VA and FHA all have loan limits while the USDA has no loan limits. Instead, loans are approved using debt-to-income ratios. Lenders will review income of all borrowers and take into account the debt that is on the borrower’s credit report. As long as the borrower meets the debt to income ratio requirements of 29/41 then they can qualify for their desired loan amount.
What are the USDA Guidelines?
General approval guidelines refer to debt-to-income ratios. This is calculated by adding up the income from eligible occupants and arriving at a monthly figure. Next, a monthly mortgage payment is calculated using prevailing USDA 30 year rates. USDA loans also require tax and insurance escrow accounts. The total monthly payment, referred to as PITI, for principal, interest, taxes and insurance, should be around 29% of qualifying income. The Total debt-to-income ratio includes additional monthly credit obligations along with PITI and should be at or below 41% of qualifying income. There are variances that can be made with the judgment of the individual lender. If these 29/41 ratios are exceeded, the loan may still be approved at the discretion of the lender.
Borrowers must also have at least a two year history of employment. Income is verified with pay check stubs and W2 forms from the past two years. For self-employed borrowers, the last two years of income tax returns will be needed.
A credit score of 640 is needed in order to qualify for a USDA loan however lenders are allowed to approve a loan with a score as low as 600. The 640 threshold is for those seeking a loan approval using an automated underwriting system. Scores lower than that are evaluated manually by an underwriter.
How to Qualify for a USDA Loan
Lenders will review your capacity to handle the new mortgage payment along with other monthly obligations and compare your qualifying income with monthly debt. When submitting your loan application you will be provided with a list of documents that are needed. You will be asked for your pay check stubs covering a 30 day period or two years of tax returns in the instance of a self-employed borrower.
Your credit report and credit scores will be ordered and reviewed. There will be three scores requested, one each from Equifax, Experian and TransUnion. This three digit score will range from 300 to 850. The lender will throw out the highest and lowest score from each and use the lowest middle score of all borrowers.
You will also be asked to provide copies of bank statements showing you have sufficient funds to close. While there is no down payment needed there will still be closing costs associated with the new mortgage.
How to Apply for a USDA Loan
It’s easy to apply for a USDA loan. All that is needed is your general income information, social security numbers and address and financials. You can submit your application online quickly and easily. If you have any questions about this process or any questions overall about the USDA loan, give us a call and let’s talk about the benefits of this special program.