What are USDA Loans?
USDA loans were created to help low and moderate-income families buy a home with no down payment and at a favorable interest rate – as long as the property is in a rural area.
Rural Development (RD) is an agency within the United States Department of Agriculture (USDA). RD is responsible for over 50 financial assistance programs for rural America. Among those programs, there’s a cluster of them that help people buy a home. That’s what this guide is all about.
As you might imagine, the USDA is a big bureaucracy. If you wanted to draw the straightest line to loan programs for families, it would look like this:
USDA > Rural Development > Rural Housing Service > Single-Family Housing Programs
USDA mortgages play a pretty significant role in the housing market. In fact, USDA Rural Development maintains a $212 billion overall loan portfolio, adding $38 billion worth of guarantees or grants annually.
Types of USDA Rural Development Loans
There are two main types of USDA single family housing loans designed for purchases. Both have long names, but you only need to focus on whether the loan is a guaranteed or direct. Here’s are the main differences.
Single Family Guaranteed Loan Program
- Funded by private lenders, the loan is not made by the Department
- Guaranteed (insured) by USDA
- For low and moderate-income households
Single Family Direct Home Loans
- Funded by USDA, the loan is between the Department and the borrower(s)
- For low and very-low income applicants who are without decent, safe and sanitary housing.
In addition to the two purchase loans above, there are couple more programs aimed at helping current homeowners make repairs.
Single Family Housing Repair Loans and Grants
- For low and very-low income homeowners with current USDA mortgage
- Up to $20,000 loan for repairs
- $7,500 grant
- Loan and grant may be combined
- 1% fixed interest rate up to 20-year term
Lastly, USDA mortgage may be refinanced via the USDA Streamline Refinance program. Streamline refinancing does not require a new appraisal, however there is a funding fee, just like purchase programs (more below).
For the remainder of this guide, we will be principally concerned with the Single Family Guaranteed Loan Program.
USDA Rural Development Loans are made by private lenders like banks, mortgage companies and credit unions. The USDA guarantees, or insures, 90% of the loan amount. Lenders know they have less to lose should a borrower not be able to pay it back. With this government-backed assurance, lenders are able to be less restrictive about what they require of borrowers (credit, income, etc.) to make a loan.
We’re going to cover several reasons why the guarantee makes USDA loans more forgiving in more detail throughout this guide. For now, here’s a quick look at some of the guarantee’s benefits:
- No down payment (zero down)
- Not limited to first time home buyers
- No minimum credit score
- Favorable interest rate
- 29/41 qualifying ratios
- Down payment gifts are okay
- No prepayment penalty
- USDA Loans are assumable
However, like all things in life, there’s no free lunch. Here’s the catch: there’s a mortgage insurance requirement.
USDA Mortgage Insurance (MI)
As mentioned, lenders can be more forgiving when underwriting USDA loans because it is guaranteed. Mortgage premiums, which are paid by borrowers, contribute to the insurance pool run by the USDA. A large pool of homeowners who pay premiums is makes the guarantee possible.
Premiums periodically change based on overall housing market conditions. When delinquency and foreclosure rates are low, premiums on newly funded loans can go down. And vice versa. Premiums remain the same over the life of the loan; they are set from the beginning. Any rate changes stipulated by USDA only affects new loans.
There are two kinds of mortgage insurance.
Upfront Guarantee Fee
The first kind or mortgage insurance is the upfront guarantee fee. It is paid at the time the loan closes. It serves the same purpose as the Upfront Mortgage Insurance Premium on FHA loans or VA’s Funding Fee.
- 2.75% of loan amount in 2016
- 1.0% of the loan amount in 2017
- The fee can be rolled into the loan
The second type of mortgage insurance is the annual fee, paid on an ongoing basis. The fee is paid on average scheduled unpaid principal balance for the life of the loan. Meaning, the rate stays the same, but the dollar amount goes down as the principal balance goes down.
- 0.50% annual insurance fee for loans closed in 2016
- 0.35% annual fee for loans closed in 2017
- Broken up and paid monthly
USDA Mortgage Insurance Example
A borrower takes out a loan for $100,000 to buy a home. At close, there a two percent funding fee, or $2000. This upfront fee it can be rolled into loan so there is not out-of-pocket expense. That doesn’t make it go away, borrowers just spread it out over the life of the loan. Which means interest is paid on it over time, just like the loan principal amount.
Each month an additional $41.67 is paid as a portion of the annual insurance fee. One twelfth of it is added to the monthly mortgage payment.