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USDA Loan

Updated on April 9, 2024
Article byGayatri Ailani
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A USDA Loan?

USDA loans are home loans for low-income people permanently or on a long-term basis living in rural areas. It is issued or guaranteed by the United States Department of Agriculture (USDA) as a part of USDA’s Rural Development Program.

USDA Loan

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Its main purpose is to provide affordable housing to the low-income population of America. The main features are low-interest rates and minimal or zero down payment requirements. Altogether, the United States Department of Agriculture’s home loan programs promotes homeownership in rural areas across the United States.

Key Takeaways

  • USDA loans are home loans featuring low-interest rate and zero or minimal down payment requirement, and it is offered to low-income residents of rural areas.
  • The main types are USDA-guaranteed, direct-issue, and home improvement loans.
  • The primary residence location, household size, and individual’s income determine whether the applicant is eligible for the United States Department of Agriculture’s home loan programs.
  • The main goal of the United States Department of Agriculture’s home loan programs is to give America’s low-income population access to affordable housing.

How Does A USDA Loan Work?

The USDA loan programs are for people living in rural areas. The loan programs assist residents in rural regions in buying, constructing, and renovating their primary residences. The people taking the loan also purchase two types of mortgage insurance. 

To attract and help low-income applicants, the United States Department of Agriculture’s home loan programs is designed to offer lower interest rates than those of traditional mortgage products. As a result, interest rates for USDA loans are frequently lower than those available elsewhere. Furthermore, they can be used by borrowers whose credit scores are so low that they might not be qualified for a conventional mortgage.

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Types

Different types of USDA loan programs are as follows:

  • USDA-guaranteed loans: These loans are offered by Section 502 of the Housing Act of 1949; lenders authorized by the United States Department of Agriculture issue them, and the USDA guarantees the repayment in the event of borrowers’ default. An applicant’s income cannot exceed 115% of the area median income.
  • Direct-issue loans: These are offered per Section 502 of the 1949 Housing Act. Instead of being distributed by intermediaries, they are issued directly by the USDA. To qualify for the direct-issue loan, a borrower’s income cannot exceed 50% to 80% of the area median income.
  • Home improvement loans: Under Section 504 of the Housing Act, loans for home improvements are offered. They combine loan and grant amounts to provide borrowers with up to $27,500, essentially a combination of loans and grants. Applicants must have a household income of less than 50% of the area median income to be considered.

Requirements

Any individual who wants to buy USDA loans must be eligible to fulfill the following criteria that include;

  • Should be a citizen or a permanent resident of the US.
  • Property under consideration should be the primary residence.
  • Property must be located in a rural area having fewer than 35,000 residents.
  • Applicant’s income should be below the pre-set limits given the income limit vary by program and area. However, the applicant’s annual income should be sufficient to meet the repayments.
  • Applicant’s debt-to-income ratio should be less than or equal to 41%.

Examples

Some of the USDA loan examples are the following:

Example #1

Mr. A is a resident of a Yukon–Koyukuk Census Area, Alaska. He applied for a USDA loan to finance his primary residence. He is eligible and got the loan because he is using the loan to purchase a primary residence; his annual income is around $300,000, which is lower than the USDA loan limit, and his debt-to-income ratio is below 41%.

Example #2

John is a first-time home buyer, and saving for a down payment is challenging due to his financial condition. His first choice was an FHA loan to finance the house with a price of $200,000, but he could not arrange the $7000 (3.5%) for a down payment. So he applied for a USDA loan and obtained 100% financing with zero down payment.

Pros And Cons

The pros of the United States Department of Agriculture’s home loan programs are as follows:

  • The customers can get zero down payment options; in other words, the USDA loans require no down payment.
  • Charges very low annual fee.
  • People with low credit scores and income can obtain it.
  • The United States Department of Agriculture’s home loan rates is lower than conventional home loan rates.
  • These loans are less risky as the federal government backs the loans.

The cons of the United States Department of Agriculture’s home loan programs are as follows:

  • The home or the property to qualify for the loan should be located in a rural area.
  • These loans are accessible only to very low-income earners.
  • The loans should be used exclusively to buy the property for permanent residence and not for investment purposes.

USDA Loan vs FHA Loan vs VA Loan

  • USDA loan programs are available in specific rural parts of the country, whereas FHA loans are available in any part of the country.
  • Income restrictions are applied to access the USDA loans, whereas FHA loans do not have income restrictions to qualify for the loan, and a low credit score is also acceptable.
  • USDA loans are backed by the US Department of Agriculture, whereas the Federal Housing Administration backs the FHA loans.
  • The department of veteran affairs guarantees VA loans; they are accessible to servicemembers, veterans, and eligible surviving spouses. In contrast, USDA and FHA loans are guaranteed to middle and low-income individuals in the country.

Frequently Asked Questions (FAQs)

What is the minimum credit score for a USDA home loan?

USDA has not set any minimum credit score requirement for home loans hence borrowers with low credit scores can apply for it. However, approved lenders offering it necessitates a minimum credit score of at least 640.

What is the income requirement defined by a USDA loan?

The borrower must have a minimum of two years of steady income. Additionally, the borrower’s income must be below a particular limit. While the exact value depends on the area and the number of residents, it should generally be less than the following limits: $74,750 for a family of one to four people or $98,650 for a family of five to eight people.

What are the common reasons for USDA loan denial?

Some of the reasons for the loan denial are the following:
1. Unverifiable household income 
2. Undisclosed debt
3. Unemployment situation during the loan application process
4. Decrease in credit score
5. Change in the debt-to-income ratio

This article has been a guide to what is USDA Loan. We explain its types, examples, requirements, pros & cons, and comparison with FHA and VA loans. You may also find some useful articles here –

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