The United States Department of Agriculture first introduced its home loan program back in 1935 when the economy was still struggling from the throes of the Great Depression. One of the goals of the program was to provide a financing option with as little cash to close as possible while at the same time populating underserved and sparsely populated areas. Today, the USDA loan is the best low-cost way to finance a home located in a rural area.
Conventional loans, such as those approved using Fannie Mae or Freddie Mac guidelines, have specific “comparable sales” requirements. A comparable sale is the identification of a recent sale of a similar property located in the area, most typically within one mile of the subject property. There needs to be at least three such properties listed on an appraisal report.
In addition, these sales need to have occurred ideally within the last six months, but exceptions can be made. However, no “comps” should be more than 12 months old. This is where the conventional loans run into trouble. In a sparsely populated, rural area finding three recent sales of similar properties is a challenge. USDA guidelines make allowances for this situation.
The USDA loan does not require a down payment and also provides a guarantee to the lender should the loan ever go into default. There are three such government-guaranteed loan programs, the other two are the VA and FHA programs. If the USDA financed home does go into foreclosure the lender is compensated for the loss. This guarantee is financed by two separate forms of mortgage insurance, an initial policy that is rolled into the loan amount and an annual policy paid in monthly installments.
There are also limits on household income with a USDA loan. In order to qualify, household income of all occupants 18 years of age and older cannot be greater than 115% of the median income for the area. The USDA loan is offered as a 30 year fixed rate program for a primary residence.
Where can a USDA loan be used? An eligible area is one where the United State Census Bureau has reviewed and designated the area as such. Yet a rural area cannot be determined simply with a visual observation. Instead, an area is deemed rural by the Census Bureau. An officially declared rural area is one that does not fall into any Urbanized Areas of 50,000 people or more or an Urban Cluster of at least 2,500 in population. If a property falls outside either of these zones, it falls into the Census Bureau’s rural category and thus eligible for a USDA loan.
However, because the Census is taken every 10 years, what was once a rural area now looks like anything but one. As population centers expand, they move their boundaries outward. Typically a developer will start a new subdivision just outside of an urbanized area. Homes located here are often priced lower than their urban neighbors and entices the population to move into more affordable homes.
Over time, the area that was once sparsely populated, if at all, is now an Urban Area or Urban Cluster. But not yet. Not until the Census Bureau after the Bureau takes its next poll in 2020. The Census is taken every 10 years and during that time, the population landscape can change.
How does one find out if a home might be eligible for USDA financing? The most efficient way is to gather the property address and provide it to a USDA-approved mortgage company. The prospective buyer provides the address and the lender enters that information into a database to show whether or not the home is indeed USDA eligible. Because population centers move this program makes an attractive option for those wanting a low-cost, competitive mortgage program.