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The United States Department of Agriculture, also called USDA, offers the mortgage commonly called the USDA home loan.
The mortgage is aimed at helping people with modest incomes acquire a home located outside major cities all across the United States.
Like most mortgage programs, there are good points and bad points to the loan. Listed below are the major pros and cons of USDA loans and how they can impact a borrower’s decision to purchase a home.
PROS of the USDA Mortgage
Extremely Attractive Interest Rates
The interest rates charged for the USDA mortgages are surprisingly low. They are typically lower than conventional rates.
Loans approved by the USDA are insured up to 90 % of the beginning mortgage amount. The guarantee stems from the fees charged by USDA for the home loans.
All borrowers pay an upfront fee when the loan is approved and also must pay monthly fees on the loan. The upfront portion can be added to the total loan amount and paid over the term of the mortgage.
Potential for 100% Financing Based On Appraised Value
Probably the most appealing feature of the USDA loan is the option to purchase a home without a down payment.
USDA rules will allow a borrower to get a loan that is up to the amount of the appraised value of the property. This means a home that is worth $185,000 and is being sold for $179,900 can be financed without making a down payment. Plus, you can roll in all of your closing costs and prepaid items up to the appraised value in this scenario.
This one aspect of the USDA loan can save buyers thousands of dollars in out-of-pocket expenses. Instead of paying 3% or 5% or even 20% of the asking price at the time of purchase, buyers can save that money and use it for other things.
No Restrictions on Loan Size
Conventional loans, along with government-backed loans like the VA and FHA loans, have a restriction on the mortgage amount. This means that borrowers are free to consider homes priced at various ranges without worrying if the particular loan amount will cause the loan to get declined.
Cash Reserves are Not a Requirement
Some loans have a cash reserve for borrowers. This means that borrowers have access to funds to use in case of an emergency.
The funds can be in various accounts such as checking accounts, savings accounts, stock investments, bonds, or even a retirement account. So long as the borrower can use the funds at their discretion, that money is referred to as cash reserves.
Some lenders will require borrowers to have cash reserves equal to 3 months of home payments. Other lenders and loans will ask that borrowers have as much as 6 months of cash reserves.
USDA loans do not have any type of cash reserves restrictions. Once again, this saves the borrower from having to have significant amounts of money for the purchase of the home.
Closing Costs May be Paid by the Seller
Sometimes a home sale is a matter of negotiations. For example, a seller may be willing to accept a slightly lower price if the buyer can guarantee a fast closing or closing without a home inspection.
Other times, a seller may be willing to pay the closing costs if the buyer is willing to pay the full asking price.
Each case is different and should be handled by a professional real estate agent in order to follow lending guidelines.
But the USDA rules will allow a seller to pay up to 6% of the home’s selling price in the form of closing costs for the mortgage loan.
Debt to Income Ratio
Most loans will use two calculations to review a borrower’s debt in comparison to their overall income. One ratio looks at just the proposed new mortgage payment compared to the monthly gross income, and the other ratio looks at both the new mortgage payment plus the other debt payments in comparison to the borrower’s monthly gross income.
With the USDA loan, the borrower’s new mortgage payment plus their current debt payments may not be more than 41% of the gross monthly income. Of course, with a higher credit score (680 or above at the time of this writing), you can get approved at a higher debt-to-income ratio. This makes it easier to calculate and easier to qualify for most homebuyers.
Relaxed Credit Guidelines
Besides the possibility of getting a home with no down payment, the other feature that attracts the most applicants for the USDA loan is the relaxed credit requirements.
Some lenders and mortgage loans insist that borrowers have a high credit score, such as 700 or above to qualify for the absolute best interest rates on a mortgage loan.
If someone with scores slightly below that level gets approved, they are often hit with additional lender overlays, more fees, and higher interest rates.
The credit requirements for USDA are more in line with the FHA and VA lending guidelines. People that have either minimal credit or have re-established their credit over the past 2 years are usually good applicants for a USDA rural home loan.
No Penalty for Early Payoff
USDA does not charge a penalty for anyone that pays off the mortgage early.
Paying a loan off early can happen in several ways. People can make an extra payment towards their loan, such as using part of their tax refund each year to make an additional home payment or simply adding a few dollars above the loan payment each month.
And paying the loan off early can be done 2 years after the loan is closed or it can happen 25 years after the loan is closed. Either way, USDA does not charge extra interest or any type of penalty if the loan is paid in full before the designated term is completed.
Mortgage Insurance Fees Cheaper than Other Loans
The USDA loan is often compared to the FHA loan because it is so appealing to first time home buyers. The mortgage insurance fees for the FHA loan are 1.75% of the total loan amount paid upfront and then 0.85% of the remaining loan balance each year, which is spread over the following 12 monthly payments.
In comparison, the fees for USDA mortgage are 1% paid upfront and 0.35% of the remaining balance paid across 12 monthly payments.
Cons of the USDA Mortgage
Only Homes in Particular Areas are Eligible
The USDA loan has long been known as the Rural home loan program, and that is for one simple reason. Any home approved by the USDA program must be located within an area that is designated as rural by the USDA.
That may sound very restrictive, but in reality, it is not. It simply means that homes located within the city limits of a major city will not be eligible for USDA financing.
According to the USDA rules, over 90% of the United States qualifies for the Rural designation.
Income for Borrowers is Limited
Since the USDA program is designed for people of modest means, there is an income limit for borrowers.
The borrower’s total home income may not be more than 15% over the median income for their area.
The income for the borrower is based on the number of people that will be living in the home after the loan is approved.
No Investment Homes or Vacation Homes
The USDA loan is intended only for borrowers that will intend to live in the property as their main residence.
USDA does not finance the purchase or refinance of an investment home, a 2nd home, or a vacation home.
It also means that that property must be a single-family home. Duplexes and other kinds of multiple-family properties are not approved for USDA financing.
Mortgage Insurance is Required
As previously mentioned, all USDA loans require two types of mortgage insurance.
The first type of mortgage insurance is the upfront fee, which is 1% of the original loan. The 1% fee may be combined with the mortgage amount and repaid over the duration of the mortgage.
The other type of mortgage insurance is a monthly fee. The monthly fee is 0.35% of the remaining balance and is calculated each year, then divided across the next 12 payments.
No amount of down payment will remove the requirement for these two kinds of mortgage insurance. The fees are assessed on all USDA loans.
Cash-out Refinance not Allowed
Unlike most other types of mortgages, the USDA does not offer any type of cash-out refinance program.
This means that if the value of the home rises and the homeowner wishes to tap into the home’s equity to use the money for other things, they will have to refinance to a different kind of loan.
Considering that the mortgage insurance rates for USDA are lower than FHA and conventional loans, refinancing to get cash could cost the borrower more money in higher fees.
Final Thoughts On The USDA Mortgage
The USDA loan is a great option for people looking to purchase a home with the least amount of money out of pocket at closing. It is also really good for buyers that have an average income and simply want to get rid of a rental payment that is not leading to equity towards the purchase of their own property.
Additional USDA Resources:
USDA has some detailed property requirements for the homes that get approved for the USDA home loan. All homes will be inspected by an appraiser and must meet the rules before the loan can be closed.
The rules cover the general condition of the home, both outside and inside. The rules also deal with the function of the basic systems like plumbing and electrical.
About the author: This article “Pros And Cons Of USDA Mortgage Loans” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of his social media profiles as well as generating new leads from his website.
MadisonMortgageGuys.com and team provide award-winning customer service to clients who need to purchase a home or refinance an existing mortgage.
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