What are USDA loans?

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In a Nutshell

The USDA makes loans for low- and moderate-income applicants, guarantees loans for homebuyers, and provides loans and grants for home improvement. There are income limits to qualify for USDA loans, and you must have an acceptable credit history — but you don’t need perfect credit to qualify. You are limited to where you can buy a home with a USDA loan, and there’s an upfront fee to pay, so USDA loans aren’t for everyone.

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The United States Department of Agriculture offers three programs to help potential homeowners buy or build homes, and help existing homeowners fix up homes, in rural or suburban areas. There’s a loan-guarantee program, a direct-loan program, and a program offering loans or grants for the repair of single-family homes.

Although these programs work differently, they all serve the same purpose: to help people with low or moderate income get home loans to buy or fix up a house in certain parts of the country.

USDA loans are available only to borrowers who will live in the home they’re borrowing for. Borrowers also have to be a citizen or eligible non-citizen, be legally able to take on the loan, and show they’re willing and able to pay it back. They also have to buy or rehabilitate a new or existing property that meets eligibility requirements. There are a few other requirements, so be sure you check with your lender or the USDA itself to find out if you’re eligible.

While USDA loans can provide affordable financing when you might not otherwise qualify for a loan — and can make it possible to buy a home with no down payment — strict limits on income and where you can build or buy mean these loans aren’t for everyone.

Plus, the upfront fee and ongoing monthly fees could make USDA loans just as expensive as other financing options.

What kinds of USDA loans are there?

There are three different kinds of USDA loans.

  • Section 502 Direct Loans: The USDA provides loans directly to low-income and very-low-income borrowers under this program. Loaned funds can be used to buy, build, renovate, repair or relocate modestly sized properties in eligible rural areas. Interest rates could be as low as 1% with payment assistance, and the repayment period could last up to 38 years.
  • USDA Guaranteed Loans: Under this program, borrowers obtain loans from approved lenders, but the USDA provides a 90% loan guarantee, similar to FHA and VA loan programs. This makes it easier to get a home loan with 0% down, even without perfect credit, because the government covers losses incurred by the lender such as if you’re foreclosed on. There are still income limits for this program, but they’re higher than for the 502 loan program.
  • Section 504 Loans/USDA Housing Repair Loans and Grants: This program provides loans up to $20,000 — and grants up to $7,500 for the elderly — to very-low-income homeowners to repair, improve or modernize their homes, as well as to remove health and safety hazards.

How do USDA loans differ from a conventional mortgage?

USDA loans differ from conventional, or nongovernment-backed, mortgages in important ways.

  • You don’t typically need a down payment with a USDA loan. The minimum down payment for most conventional loans is 5%, although some borrowers with excellent credit may be able to obtain a loan with just 3% down.
  • USDA loans may have a much lower interest rate than conventional loans.
  • USDA loans are intended for people with lower income. While conventional lenders will approve you for loans more easily with a higher income, USDA loans all have income limits that prevent you from qualifying if you make too much.
  • There are strict limitations on properties for USDA loans. Conventional loans can be obtained to buy properties anywhere, but you can obtain USDA loans only for properties in certain locations.
  • USDA loans charge an upfront fee and mortgage insurance premiums. Many conventional lenders charge fees for a loan, but they may be negotiable. And, while you’ll typically have to pay mortgage insurance on a conventional loan if you don’t have 20% down, you can request to stop paying this monthly cost once you’ve built up enough equity.

How do USDA loans work?

USDA loans work differently depending on the kind of loan you’re interested in. But all USDA loans have certain things in common. For example:

  • You won’t qualify if your income is too high.
  • Your home must be in an eligible area. The USDA Income and Eligibility Site can help you determine if you’d be eligible based on where you’re interested in buying or improving a property.
  • You can only get a loan for property you’ll be using as your primary residence or that you currently occupy.

Finally, all USDA loans are designed to make it easier to obtain a loan when you might not otherwise qualify for financing because of your income, lack of down payment or credit history.

What is the interest rate on a USDA loan?

The interest rate for 502, or direct, loans is 3.50% for most borrowers as of November 2018, but could go as low as 1% with payment assistance. For 504, or repair, loans, the interest rate is 1%.

For USDA-guaranteed loans, rates and terms vary by lender. You’ll need to comparison shop to find a loan at the best rate for you. Pay attention to both the interest rate and the fees each lender charges — you’ll want to get the most affordable loan after taking all costs into account.

What are the fees and costs associated with USDA loans?

USDA-guaranteed loans charge a 1% upfront fee and also charge a monthly 0.35% mortgage insurance fee that you’ll pay for the life of the loan. On a $100,000 loan, you’d have to pay a $1,000 initial fee and each month you’d pay $350, on top of your mortgage payment.

With 502 loans, those made directly by the USDA, you’re required to undergo homeowner education, for which you may be charged a fee.

What is the maximum you can borrow?

If you’re applying for a housing repair loan, the maximum you can borrow is $20,000. Eligible seniors can obtain an additional $7,500 in grants that don’t need to be repaid, so the USDA can help finance up to $27,500 in improvements.

For direct USDA loans, the maximum you can borrow depends on how much you’re able to repay based on your income and other debt, as well on the amount of payment assistance, if any, that you’re eligible for. And a home you buy or build with a USDA loan can’t exceed the area’s loan limits, although you can finance some fees on top of those limits.

For loans guaranteed by the USDA, the maximum loan amount will depend on what a lender is willing to finance, but it can’t exceed the appraised value or the purchase price including a variety of costs that are defined by the USDA. There are a fair number of eligible costs, so be sure to ask your lender or the USDA for details if you run into financing questions. Further, the rules for a newly built home are different — something else to ask your lender or the USDA about.

To figure out if you’re eligible for a USDA loan, you can use this tool on the Department’s website. If you want to see direct loan limits for where you’re planning to buy, use the USDA Area Loan Limit Map.

Applying for a USDA loan

The process of applying for a USDA loan varies depending on whether you want a 502 loan, 504 loan or a guaranteed loan.

Remember, if you’ll be getting a loan from a traditional lender that the USDA guarantees, compare offers from a few financial institutions, because different lenders have different qualifying requirements and charge different fees.

Who can qualify?

To qualify for a USDA loan, you must meet the following:

  • Have a low income relative to your area. Check income limits here for 502 direct loans or 504 loans, or on the Income Eligibility page for USDA-guaranteed loans.
  • Make the home you’re buying your primary residence or be the homeowner and occupy the home (for repair loans).
  • Be a U.S. citizen or meet noncitizen eligibility requirements.
  • Demonstrate that you’re willing and able to meet credit obligations.
  • Purchase a property that meets the specific criteria for your program. You can check eligible addresses for loan guarantees here, or use the USDA’s Income and Property eligibility tool to find out if the property you’re interested in is eligible.
  • Meet program-specific criteria: For example, to qualify for Section 504 financing, you must be unable to obtain affordable credit elsewhere, whereas you can generally qualify for a 502 direct loan if the home is 2,000 square feet or less and doesn’t have an in-ground swimming pool.

Bottom line: Is a USDA loan right for you?

If you want to buy, build or rehabilitate a home in a rural or suburban area and you don’t have a down payment or great credit, a USDA loan might be the right choice. Just be sure you understand all the fees associated with getting a USDA loan, and know the borrowing restrictions, so that you don’t fall in love with a home that the USDA won’t help you pay for.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher… Read more.