24 Nov, 2023

Is a USDA Loan Right for You? Weighing the Advantages and Disadvantages

Meet all the USDA requirements and pre-qualify

Buying a house in a rural area has its own perks. Right from affordable houses and apartments to less expensive living costs, investing in rural properties could be one of the best decisions in your life.

Additionally, there is a more feasible way to secure a mortgage with a USDA loan if you happen to buy a house in a rural area.

If this is something that interests you, in this blog we will weigh the advantages and disadvantages and help you find out if a USDA loan is the right one for you.

What is a USDA loan?

USDA loans are designed to assist individuals and families in rural and suburban areas to achieve their dream of homeownership and they are backed by the U.S. Department of Agriculture.

Unlike conventional loans, USDA loans offer unique features that make them an attractive option for eligible borrowers. Most of the USDA loans are issued by partner lenders approved by the U.S. Department of Agriculture.
Compared to conventional loans, USDA loans come with much lower interest rates and don’t require you to pay a down payment.

Features of USDA loans

These loans are sometimes referred to as RD or rural development loans and are targeted towards low and moderate-income homebuyers in rural areas. Let’s see how USDA loans stand out from other loan types:

Location

One of the defining features of USDA loans is that they are intended to promote homeownership in rural areas.

In order to qualify for the USDA loan requirements, homebuyers need to purchase their home in rural locations.
Income eligibility

USDA loans are tailored to assist moderate to low-income households. To meet the USDA mortgage requirements, applicants must fall under specific income criteria.

This criterion is set because the program is aimed to reach those who might face financial barriers when seeking conventional mortgages.

Check out the top 10 do’s and don’ts to qualify for a conventional loan.
No down payment

With the help of USDA loans, one can get 100% finance of the home’s purchase price as there is no upfront payment required.

This means eligible borrowers can secure a home without the need for a substantial down payment, a significant hurdle for many prospective homeowners.
Lower interest rates

USDA loans when compared to conventional loans come with lower interest rates, making home ownership more affordable over the life of the loan.

The favorable rates contribute to the overall appeal of USDA loans compared to other mortgage options.

Types of USDA loans

Before understanding the criteria for USDA loan, it's essential to explore the different types of USDA loans, each catering to specific financial situations and income levels.

Three main types of USDA loans are Direct loans, USDA loan guaranteed, and USDA home improvement loans.

All these three loans offer flexibility and accessibility to a diverse range of prospective homebuyers. Each lender’s rural housing loan requirements differ, and we recommend you check out a list of USDA’s approved list of lenders.

USDA Direct loans

They are issued for low income borrowers who are in need of necessary funding to buy their home. Based on the county where you’re located, there is a limit on how much can be borrowed.

In addition to this, direct loans may offer payment assistance in the form of subsidies or even direct payment relief.
Guaranteed USDA loans

This loan program is officially referred to as section 502 guaranteed. Under this program, USDA-approved mortgage lenders provide 30-year fixed-rate loans to borrowers in USDA-eligible locations.

They call it a guaranteed loan for a reason, as 90 percent of the loan is paid off to lenders in case of a default.

Guaranteed loans are easy to find and are a popular choice for rural home buyers than direct loans.
USDA home improvement loans

These loan programs are similar to USDA Direct but have a cap limit of $40,000 that can be used to repair or upgrade the home.

In addition to that, it also offers grants of up to $10,000 to senior low-income homeowners who are aged 62 or older.

What are the USDA requirements?

In order to meet the USDA home loan qualifications, homebuyers must meet the following criteria:

The homebuyer needs to be a U.S. citizen or legal permanent resident.
They must prove their creditworthiness and have a credit score of at least 640.
Homebuyers need to have a stable income.
Must be located in a USDA-eligible area.

Apart from the above, you might have to provide additional documentation, to prove your income status, you must be able to provide the lender with these documents:

Monthly pay stubs.
Past tax statements.
Bank statements and investment accounts.
Social security payments.

If you have all the above documents ready, fill out the form for a pre-qualification.

USDA construction loan

If you’re wondering if there’s a USDA loan to build a house, this is one of the best available options to build your home as you wish. The USDA building loans are different from that of a USDA home loan and it helps you right from the construction phase and goes on to become a permanent loan.

This specialized loan program is tailored to assist individuals and families in constructing a home in eligible areas.
So, essentially if you’re planning to build your own home from scratch, you will need funds to purchase the land and construct the property.
Initially, when you take out a loan, the loan will be processed as a construction loan but once the home has been built completely, it transitions into a 15 or a 30-year mortgage.
Later, just like a regular mortgage, all your monthly payments with interest will be processed to pay back the loan.

Looking for a USDA construction loan lender can be a bit of a task! Let us ease the burden for you. Talk to our mortgage advisor, and choose the right USDA-approved lender in no time.

Documents needed for USDA construction loan approval

The land must be located in a USDA-approved area
A USDA-approved contractor must be used.
The intended property must be a primary residence.
The borrower’s credit score must be 640.
The borrower’s income is not beyond the state’s USDA income limits.
Debt to income is not more than 41%.

If you’re planning on building a house with a USDA loan, make sure to look through the entire list of USDA-approved lenders so that you’re on the right path to home ownership.

USDA construction loan for building from scratch

USDA vs conventional loan

USDA loan	Conventional loan
1) They are designed to assist low and moderate-income individuals and families, to purchase a place of their own.	1) Conventional loans typically do not have income limits. However, borrowers are generally required to have a stable income and good credit history in order to qualify.
2) The loans are based on certain USDA requirements such as location, income, credit score, and family size.	2) The property location is not a determining factor for conventional loan eligibility.
3) There is no downpayment involved in USDA loan requirements. Lenders can finance 100% of the home's purchase price.	3) A down payment can’t be skipped in a conventional loan, with the maximum expectation being around 20% of the home's purchase price.
4) Maintaining a good credit score is one of the main criteria in USDA requirements. A score of 640 is a minimum requirement for USDA.	4) They have stricter credit score requirements and when you qualify, there are higher chances to qualify for competitive interest rates and favorable loan terms.
5) Lastly, the property must be located in a rural area as per USDA requirements. This restriction helps promote homeownership in remote areas and uplifts the community around them.	5) Conventional loans don’t have any specific property requirements. Borrowers can use the funds for homes in urban, suburban, or rural areas as they wish.

Advantages and Disadvantages of USDA loans

USDA loans offer a lot of benefits for borrowers who want to settle down peacefully amidst rural neighborhoods. Let’s quickly weigh the pros against the cons.

Advantages:

One of the most significant advantages of USDA loans is the ability to finance 100% of the home's purchase price.
They contribute to the overall development of rural areas by encouraging homeownership.
They provide targeted assistance to low-income individuals who are facing financial barriers.
USDA construction loans seamlessly transition into permanent mortgages by eliminating the need to get separate mortgages.

Disadvantages:

USDA loans are restricted to only eligible rural areas and not all rural areas.
They have specific income limits based on location and family size and high-income individuals do not qualify for USDA requirements.
The USDA loan approval process can be longer compared to some other loan types.
All the properties must meet specific eligibility criteria to qualify for USDA requirements.

Key takeaways

As with any financial decision, the choice of whether to pursue a USDA loan or USDA construction loan depends on the credit score, household size, income, and homebuyer’s ability to handle the monthly payments.

The eligibility criteria for both these loan types differ. Deciding if you want to move into a completely built house or start from scratch will help you choose what’s best for you.

If you fall within the low-income group and seek additional assistance to become a homeowner, HLRI will assist you in every step of the way.