There’s a lot to like about USDA loans. First, they are “zero down” (no down payment required). Second, they are not limited to just first time homebuyers. Lastly, there’s no minimum credit score requirement for borrowers.
Rural Development (RD) guarantees the loan made by the lender up to 90% of original loan amount. This creates the conditions for lenders to be more accommodating from an underwriting standpoint. For borrowers, that means qualifying for a USDA loans is easier than other mortgage programs.
USDA Guaranteed Benefits
When underwriting a loan, lenders evaluate several pieces of information about the buyer and property. We previously covered the eligibility of each, now we can talk about requirements and guidelines. These are the pieces of the puzzle that are looked carefully by loan underwriters.
USDA Maximum Loan Amount
- Loans up to 100% of appraised value plus the one-time guarantee fee may be rolled in, meaning the loan amount can go above 100%.
- Other fees may be rolled into the loan. Fees – like eligible closing costs, lender fees and repairs – may be included to keep out of pocket costs to a minimum.
If appraised value exceeds purchase price, the net difference can be used for closing fees. For example, say the purchase price of a home is $100,000. The appraised value comes back at $103,000. That means there’s now an extra $3,000 that can be applied to closing costs. Plus, you can add the USDA Upfront Guarantee Fee.
Maximum Purchase Price
No maximum is set by USDA, but there is maximum allowable household income which becomes the natural limiter for the size of the mortgage. The borrower’s Housing and Debt ratios (covered below) determine the qualifying loan amount.
USDA Mortgage Insurance (MI) Rates
- For purchases, there’s a one-time guarantee fee of 1.0% in 2017.
- For refinances, the guarantee fee is 1.0% in 2017.
- And USDA loans have an annual fee, broken up and paid each month. The fee is 0.35% in 2017.
Loan to Value (LTV)
- No maximum combined loan to value (CLTV) is set by USDA.
- Rural Development only guarantees the max loan amount, which is based on the appraised value.
- The lender decides how much risk they’ll take.
USDA Loan Terms
USDA loans are made on a 30-year term with a fixed-rate. This adds stability for the borrower. There are no surprises in a market with climbing interest rates as would be the case with an adjustable rate loan.
Assistance Programs Allowed
Additional funds may be used in conjunction with a USDA loan to help with the down payment or to cover some of the closing costs.
- Rural Development (e.g. RD Grants)
- Gifts from family
- Down payment Assistance Programs (state and regional)
- Seller concessions
- Mortgage Credit Certificates
- Temporary or permanent buy downs (an interest rate reduction in the early years of the loan paid for at closing)
USDA Loan Underwriting
Lenders make loans when three main criteria are met: the borrower’s credit, their capacity to repay the loan and the collateral (the property itself). These are know as the Three C’s.
One of the ways that lenders know whether borrowers will pay a loan back is to look at their credit history. Borrowers who’ve paid their bills on-time and in-full tend to keep on doing so with respect to a mortgage. Here are some of the USDA requirements and guidelines concerning credit.
- USDA does not set minimum FICO score.
- Nontraditional credit is allowed (e.g. rental payment history or utility payments).
- Applicants must demonstrate an ability to meet mortgage payments on-time and in-full.
- Lender overlays may be added. Overlays are additional guidelines or requirements imposed by a lender that extend USDA rules.
Lenders want to know if you have the ability to pay the loan back. The easiest way to figure that out is by looking at the following:
- Employment – ideally on a job for 2 or more years.
- Income – verified by W2s and bank statements.
- Debt – history and current outstanding debt is verified with a credit report.
USDA Qualifying Ratios
Qualifying ratios give lenders a way to figure out how much money a borrower has each month to make their mortgage payment. There are two of them.
The first is the Housing Ratio, also known as the Front End Ratio.
To arrive at the ratio number, you figure out what the expected mortgage payment is going to be. Mortgage payments include includes principle, interest, taxes and insurance (PITI).
Next, you divide the mortgage payment (PITI) by the borrower’s monthly income before taxes. Here’s the formula:
Monthly Mortgage Payment ÷ Gross Monthly Income = Housing Ratio
Next up is the Debt to Income Ratio (DTI) also known as the Back End Ratio. To get it, one combines the expected mortgage payment plus all the other monthly debt obligations (student loans, revolving credit payments, etc.) together. Then divide the total monthly debt expense by the gross monthly income. This gives lenders and idea about the amount of free standing cash a borrower has each month under the full weight of all debt obligations. Here’ the formula:
Total Monthly Debt Expense ÷ Gross Monthly Income = Debt to Income Ratio
For USDA loans, qualifying ratios are 29/41. That’s shorthand to say that a borrower should have a Housing Ratio of 29 and a Debt to Income Ratio of 41.
Strong compensating factors may justify higher ratios, but in general, the 29/41 USDA guideline is the norm.
USDA Reserve Requirements
Reserves are the funds (money) borrowers have on hand after buying or refinancing a home. It’s a way of asking how much dry powder is still in the keg when everything is said and done. USDA guidelines do not set a reserve requirement. Nor is there an asset limit.
In fact, borrowers aren’t even required to have a bank account. Just a quick bit of interesting trivia: 10 million households in United States don’t have a bank account. Yep, USDA allows loans to unbanked borrowers.
Down Payment / Equity
Because USDA loans are zero down loans, there will typically be no equity in the home when the loan is made. It will have to accrue over time. Equity is one of the typically factors when lenders evaluate risk; it means the borrower has skin in the game. Instead, the condition and suitability of the property to serve as collateral for USDA loans is pinned on the appraisal/inspection.
USDA Appraisal / Inspection
Appraisal / inspections ensure that the lender is making a loan in an amount suitable for the property. They establish fair market value. Lenders also need to verify that the property meets Rural Development’s guidelines. The home must be suitable (safe and sanitary) to live in by the new occupants.
- Must meet HUD minimum property standards
- Must be located in rural area as designated by USDA
- Dwellings must be considered modest for the area (e.g. under 1,800 sq. ft.)
- Determine whether repairs must be made
- Disclose safety, environmental or health hazards
- Disclose energy inefficiencies
- Verify that it is a non-income producing property
PUTTING IT ALL TOGETHER
USDA requirements and guidelines are very lenient compared to other types of guaranteed loan programs like VA loans. However, underwriters still evaluate the Three C’s. And lenders may impose their own rules, called lender overlays.