What are USDA loans?

If you have low-to-moderate income and want to buy a home in a rural area, you might consider taking out a USDA loan.

There are several types of USDA loan programs. Each is meant to help people who wouldn’t qualify for other types of home loans to buy, build or make repairs to a home in a rural area. Although eligibility isn’t limited to first-time homebuyers, these loans can be especially helpful if it’s your first time out, because USDA loans generally don‘t require a down payment.

We’ll go over the different types of USDA loans and look at their eligibility requirements. We’ll also compare USDA loans with FHA loans, and we’ll review a few questions to think about before applying for a loan from the USDA.

• How do USDA loans work?
• Section 502 direct loans
• USDA-guaranteed loans
• USDA housing repair loans
• Who qualifies for a USDA loan?
• Is a USDA loan or an FHA loan better?

How do USDA loans work?

The U.S. Department of Agriculture offers three types of loan programs to people who want to buy or repair a single-family home in a rural area.

These programs are intended to help people who otherwise couldn’t afford to buy a home or continue living in an existing home. The USDA also says it has the broader goals of supporting community well-being and bolstering rural economies.

Each type of loan works a little differently.

Section 502 direct loans

Through its Single Family Housing Direct Home Loans program (also known as Section 502 direct loans), the USDA lends money directly to homebuyers. Some people who take out direct loans from the USDA also qualify for payment assistance, which temporarily lowers the monthly payment they owe.

If eligible, you can use these loans to buy an existing home, and even repair it, if needed. You can also use the money to build a new home.

You don’t have to make a down payment, unless your assets are above a certain threshold. Another plus: You don’t have to pay for mortgage insurance.

The loans have a fixed interest rate that’s determined by market rates. If you qualify for payment assistance, the effective rate can be as low as 1%. Loan terms are typically 33 years, though borrowers with very low income may have up to 38 years to repay the loan.

The loan amount is determined by your income, assets, debt-to-income ratio and other financial details, but it can’t be higher than the USDA’s loan limit for the area. And this type of loan can’t be used to buy or build a home that’s unusually large or valuable for its location, that has an in-ground swimming pool, or that’s constructed to serve as the site of a business or to generate income.

USDA-guaranteed loans

The USDA guarantees some loans offered by private lenders through its Single Family Housing Guaranteed Loan program (Section 502 guaranteed loans). These loans can be used to buy an existing home, as well as cover the costs of repairing or improving it. They can also be used to build a new home or to refinance another USDA-guaranteed loan or Section 502 direct loan that the homeowner previously took out.

USDA-guaranteed loans don’t require a down payment. And while you don’t have to pay for mortgage insurance, these loans come with a yearly “guarantee” fee that’s worked into your monthly payments.

USDA-guaranteed loans can be as much as 100% of the appraised value of the home. If the sale price is less than that, the homebuyer can use the difference to cover repairs or pay closing costs, the costs of setting up utilities or some other expenses related to the purchase.

The participating private lenders determine what interest rates to offer, but they have to stick to fixed-rate loans with 30-year terms.

To be eligible, a home needs to be a single-family dwelling (which can include a house, condo, or modular or manufactured structure) that meets standards set by the Department of Housing and Urban Development. And it can’t be on a lot that’s particularly large for where it’s located.

USDA housing repair loans

Loans offered through the Section 504 Home Repair program are meant to provide funds to bring homes up to date, make needed repairs, or eliminate health hazards and safety risks. For example, loans may be used to fix structural issues or to connect a home with a water or sewer line. These loans also may be used to install or fix a heating system, put in a new roof or insulate the home so it can be lived in comfortably during the winter.

Loans amounts can’t be more than $20,000, and borrowers have 20 years to pay the loan back. The interest rate stays at 1% for the life of the loan. The program also makes grants available for the same use for eligible people who are at least 62 years old and can’t afford to repay a loan.

Who qualifies for a USDA loan?

To get a USDA loan, the home you want to buy or repair must be in an eligible area. Homes usually need to be located in an area where the population is below 20,000, though in some cases homes in areas with a population as high as 35,000 are eligible. 

There are other requirements that vary depending on the type of loan you’re applying for.

• Section 502 direct loans — Applicants need to have income no higher than the USDA’s low-income limit for the county where they’re buying or building a home. They also have to be able to show that they can pay back the loan. They must plan to use the property as their primary residence, and they can’t already have other housing lined up or have the option to take out a reasonably good loan from a different source.
• USDA-guaranteed loans — Applicants need to have household income that isn’t more than 115% of the median income. They have to show that they can repay a loan, but it’s OK if they have alternative proof of credit history in place of conventional credit reports and scores. They need to plan to use the property as their primary residence, and they must be unable to get a no-PMI (private mortgage insurance) conventional loan.
• USDA housing repair loans — Applicants need to own the home and be living in it. Their income has to be less than 50% of the median income for their county, and they must not be able to find a loan they can afford from another source.

Is a USDA loan or an FHA loan better?

USDA loans and FHA loans each have pros and cons. Which one is better for you depends on your circumstances.

A USDA loan may be less costly than an FHA loan, so it’s worth considering a USDA loan first if you meet the eligibility requirements. USDA loans typically don’t require down payments, making them attractive to homebuyers who don’t have much money saved up. FHA loans, on the other hand, require down payments starting at 3.5%.

Direct loans from the USDA don’t require you to pay for mortgage insurance, while FHA loans require monthly mortgage insurance as well as a one-time mortgage insurance premium upfront.

But FHA loans don’t have income-eligibility caps like USDA loans do, so they’re available to people with a wider range of incomes. And you can use an FHA loan to buy an eligible home anywhere in the U.S., unlike USDA loans, which are restricted specifically to rural areas that meet population thresholds.

You aren’t excluded from any geographic location with an FHA loan, though the maximum amount you can borrow varies by county.

What’s next?

Here are some questions to ask before you apply for a USDA home loan.

• Is the property you’re interested in located in an eligible area? Search the USDA’s map to confirm the address is eligible for a loan.
• Do you qualify for a grant instead of a loan or in conjunction with a loan? Homeowners who are 62 or older and who don’t have the means to pay back a repair loan may qualify for a repair grant from the USDA. Grants can be as large as $7,500 and are only for eliminating dangers to health or safety.
• Could you get affordable financing from a conventional lender? USDA loans are available only to people who can’t find another acceptable loan. You may want to ask for quotes from a few lenders to confirm that conventional loans are, in fact, out of reach for you.