USDA home loans allow 100% financing when purchasing or refinancing a home in USDA-designated rural areas. These home loans are guaranteed by the United States Department of Agriculture.
USDA does have geographic and income limitations which reduces the number of homes and borrowers that qualify. USDA home loans have their own unique underwriting guidelines and closing costs like other mortgage loan programs.
USDA Home Loans Overview
The USDA Guaranteed Rural Housing Program (GRH) program offers 100% financing for low to moderate income buyers in rural areas. There are three major criteria for USDA home loans:
- The property must be an eligibility area
- The household income must meet USDA restrictions
- The USDA must have funds able for the program.
While USDA home loans are great programs for first-time buyers, it’s not limited to first time buyers. Anyone that meets the qualifying criteria is eligible for a USDA mortgage.
USDA Home Loan Highlights
Below are some highlights for USDA home loans.
- Maximum Loan-to-Value (LTV) is 103%,
- Minimum 580 credit score is required,
- Maximum 6% Seller Concessions are allowed,
- First Time Homebuyers may be required to complete homebuyer education class,
- Borrowers with no credit score are eligible (with manual underwriting),
- There aren’t any reserve requirements.
Non-Purchasing Spouse’s Credit
Government-backed home loans, like USDA, require that the debts from a non-purchasing spouse be counted in the debt-to-income (DTI) ratios. The good news is that the credit of a non-purchasing spouse (NPS) is not considered a reason to deny a loan – meaning the credit scores for the NPS don’t matter.
A full credit report for the non-purchasing spouse must be obtained to determine what obligations should be included in the DTI.
The Community Property States are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico,
Texas, Washington, and Wisconsin.
USDA Home Loan Restrictions
USDA home loans do have a number of restrictions for eligibility. The most notable relate to the property’s location, the borrower’s income, and the program’s availability of funds.
USDA home loans are geographically restricted. The subject property must be located in an eligible rural area. Here’s how to lookup a property on USDA’s website: USDA Rural Area Map.
USDA also requires the the property be a primary home; in other words, no vacation homes or investment properties. Moreover, they must be one unit properties.
USDA does not allow the property to be income producing. Anything related to income-producing farm activities makes the property ineligible.
USDA home loans are for low-to-moderate income families; therefore, there are income restrictions. The qualifying income must be less than, or equal to, 115% of the area’s median income.
USDA income calculations are unique in that all working household member’s income must be included for eligibility. This includes spouses, kids over the age of 18, and anyone else occupying the property over the age of 18 and working.
The adjusted household income cannot exceed the limit set by Rural Development for the state/county where the property is located. Verification of income limits can be found at the following link: Single Family Housing Guaranteed Income Limits.
The USDA calculations are complex. Just know that they are complicated and that it’s impetrative to work with a mortgage lender that has comprehensive knowledge of the guidelines.
USDA’s guidelines are set for a front-end housing ratio of 29%. This means that the standard guidelines want the monthly mortgage payment (including taxes taxes, insurance, etc.) to be less than, or equal to, 29% of the total gross monthly income.
USDA also wants the total debt-to-income (DTI) ratio to be less than, or equal to, 41% of the income. The DTI includes the monthly PITI mortgage payment plus any other monthly credit obligations.
Exceptions may be granted for higher debt ratios when compensating factors are present. The USDA underwriters will need to approve the exception.
For example, a USDA underwriter may allow the DTI to exceed 41% if the borrower has higher credit scores, ample asset reserves, a long-term job history, or has a current housing payment that is comparable to the new mortgage payment.
Surprisingly, USDA mortgage guidelines impose a maximum for the amount of liquid cash for a borrower. USDA requires that liquid funds (like money in checking and savings accounts) be less than 20% of the purchase price.
For example, a buyer with $50,000 in a savings account will not be allowed to obtain USDA financing when purchasing a $200,000 home. The reason for this is because the the $50,000 in savings is above 20% of the home’s purchase price ($200,000 * 20% = $40,000).
Retirement accounts are not considered liquid accounts.
Closing Costs for USDA Home Loans
The estimated closing cost for USDA home loans are comparable to other loan programs with two major exceptions. First, USDA requires an upfront guarantee fee as well as an annual fee (that is included in the monthly mortgage payment). Second, USDA allows for closing cost to be rolled into the mortgage without requiring seller concessions.
USDA Guarantee Fee
USDA home loans require two forms of a “guarantee fee”. Like other home loans with upfront MIP, the USDA’s upfront guarantee fee costs 1.0%. Additionally, there is an annual fee of .35% that is added to the monthly payment for the life of the loan.
This guarantee fee is the equivalent of USDA’s private mortgage insurance. These fees allow USDA to offer 100% financing by ensuring they have the necessary funds to cover potential property foreclosures.
USDA Guarantee Fee Example
For a $200,000 USDA home loan, the upfront guarantee fee is $2,000 (or 1% of the loan amount). The good news is that the upfront guarantee fee can be rolled into the mortgage note. The final loan amount would be $202,000.
For a $202,000 final loan amount, the annual fee of .35% adds $58.92 to the monthly payment. This is calculated by multiplying the final loan amount ($202,000) by the annual fee (.0035) and then dividing it by 12 months ($200,000 x .0035 / 12 = $58.33).
Closing Cost Rolled In
What makes USDA loans even sweeter is that they allow for closing cost to be rolled into the loan (when the upfront guarantee fee is also being rolled into the note). This means that the buyer may be able to come to closing with zero dollars out of pocket.
USDA will allow a loan-to-value (LTV) of 103%. This means the maximum loan amount for a $200,000 purchase will be $206,000.
The one-time, upfront guarantee fee of 1% is automatically rolled into the note. With zero down payment, this makes the Loan To Value (LTV) 101% because the final loan can exceed the purchase price.
Eligible closing cost (including discount points to buydown the interest rate), lender fees, repairs, etc. may be rolled into the loan amount. This means that loan to value (LTV) can be above 100%.
The appraisal will ultimately determine if additional closing cost can be rolled into the loan. The home must appraise for more than the purchase price in order to finance closing cost.
For example: Let’s assume a home is being purchased for $200,000 with zero down payment. The property appraises for $206,000. USDA will allow $4,000 of additional closing cost to be rolled into the loan. ($200,000 base loan amount + $2,000 upfront guarantee fee of 1% + $4,000 of closing costs = $206,000 final loan amount).
USDA’s Availability of Funds
USDA can occasionally run out of funds for closing. While rare, this can happen and can cause extreme stress. Obviously the USDA understands the severity of this situation and will provide as much intel as possible.
USDA will allow rate-and-term refinances for homeowners with existing USDA home loans. There are also streamline USDA refinance opportunities as well. Please call us if you have any questions about these programs.
Loan Officer, NMLS # 729612