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As rising rates squeeze homebuyers dry in cities, USDA loans offer an escape

·7 min read
As rising rates squeeze homebuyers dry in cities, USDA loans offer an escape
As rising rates squeeze homebuyers dry in cities, USDA loans offer an escape

June is almost over, and that means President Joe Biden's "National Homeownership Month" is, too.

But with interest rates and home prices still rising, it's unclear whether homeownership is getting much more attainable.

Some experts predict a housing correction is coming, but prices won't crash dramatically. Prices might shrink an annual 5% by the middle of next year, Matthew Pointon, a senior property economist with Capital Economics, said last week.

Aspiring homeowners will need to dig deeper — or look further afield.

So long as you're open to the idea of buying a home in a rural or suburban area, you can always take advantage of a major loan program designed to help you achieve homeownership more quickly and cheaply. Here's why USDA loans deserve another look.

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What is a USDA loan?

Unlike a conventional loan, USDA loans are backed by the government and don’t require any down payment. You can use it to finance the purchase of a home and essential household equipment. You can also put the funds toward repairs and rehabilitation.

With a USDA loan, low- to moderate-income Americans in less populous areas can make the dream of homeownership achievable sooner than they might have thought.

The USDA mortgage loan program was designed to make it easier for people to become homeowners outside of major metro areas.

It boasts low interest rates and lower credit-score requirements than other loan types, such as conventional mortgages.

How do these loans work?

USDA loans are backed by the United States Department of Agriculture, meaning if you fail to make your payments, the government will step in.

This assurance allows mortgage lenders to take on riskier borrowers, knowing that should those borrowers default, the loan will still be repaid.

USDA loans come with a few fees, but those fees tend to cost less in the long run than the mortgage insurance expenses associated with other types of loans.

Of course, this program isn’t open to everyone. You’ll have to meet the USDA’s eligibility requirements to qualify.

USDA mortgage eligibility

To qualify for a USDA loan, you have to be a U.S. citizen or have permanent residency in the U.S.. You must also agree to make the home you purchase your primary residence.

Your debt and credit score are also important. You’ll typically need a credit score of at least 640, but some lenders allow applicants with scores as low as 580.

Mortgage lenders also will look at your debt ratios. Your front-end ratio (the percentage of your gross monthly income that your mortgage payment accounts for) should be no more than 29%. And your back-end ratio (all your monthly debt and mortgage payments divided by your gross monthly income) shouldn’t exceed 41%.

If you don’t meet those requirements, you may still qualify if you have a credit score of 680 or higher.

Another plus of having a higher credit score: If it’s 640 or higher, you could benefit from a streamlined application and underwriting process.

Essentially, what lenders are looking for is an acceptable credit history and lack of any debts being sent to collections over the last 12 months.

Types of USDA loans

Single Family Housing Guaranteed Loans

This loan program helps lenders provide 100% financing for low- and moderate-income households. The USDA guarantees 90% of your mortgage amount to mitigate the risk to lenders.

Your income can’t exceed 115% of the median household income in the area. Interest rates vary by lender and there’s a 30-year payback period.

There’s also a one-time upfront fee of 1% and an annual fee of 0.35%, with a 4% late charge fee.

Single Family Housing Direct Home Loans

This loan program is funded straight through the USDA (instead of lenders) and is for low- and very-low-income households. However, the requirements are a bit stricter, compared to guaranteed loans.

Your income must lie below the low-income limit in the area and you must be without safe and sanitary housing and unable to secure a loan through other sources (but not suspended or debarred from participating in federal programs).

The property you purchase is restricted to 2,000 square feet or less and the market value can’t exceed the area loan limit.

As of June 1, the interest rate is 3%, although this can drop to as low as 1% with payment assistance. There’s also a 33-year payback period, which can be extended to 38 years for very-low-income borrowers.

You’ll pay a non-refundable credit report fee of $25 upfront and there may be other costs included in the loan amount as well.

How to apply for a USDA loan

Check the income limits in your area and look into the other eligibility requirements to determine whether you qualify for a USDA guaranteed or direct loan. You’ll also want to figure out how much you can afford to meet those monthly mortgage payments.

To apply for a guaranteed loan, the USDA features a list of approved lenders by state and recommends that you do some comparison shopping first. The lender handles the loan application process while coordinating with Rural Development staff.

For a direct loan, you’ll submit your application to your local Rural Development office. The USDA site also offers resources and tools to help with the process. Just select your home state for any state-specific forms or resources.

USDA loan FAQ

Do you pay private mortgage insurance (PMI) on a USDA loan?

USDA loans do not require PMI since they’re backed by the government, mitigating the risk to lenders (for guaranteed loans). PMI applies to conventional loans, and only if you make a down payment of under 20%.

Can you refinance a USDA loan?

Yes, you can refinance a USDA loan — with either a conventional loan or another USDA loan.

There are three refinancing options available that apply to both direct and guaranteed USDA loans that are at least 12 months old and meet 30-year loan terms: the non-streamlined, streamlined and streamlined-assist products. For the latter two, you don’t require a credit report, home appraisal or property inspections.

The streamlined-assist option is the most popular — you need to have made at least 12 consecutive payments on it, but the lender doesn’t need to verify your income or debt-to-income ratio.

For the streamlined option, you must have made your payments on time for the past six months. You will need to provide proof of current income and meet some debt-to-income requirements, however.

The non-streamlined option requires borrowers to get a new appraisal as well as proof of income.

What areas are eligible for a USDA loan?

Huge swaths of the country are eligible for assistance through the USDA loan program. It’s not meant only for farms or homes in the middle of nowhere.

Check out the USDA’s site to find out whether your location qualifies.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.