What is a USDA Loan? Eligibility and Requirements Explained

Written by Jordan BlansitUpdated: 28th Dec 2021
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USDA loans provide an opportunity for low- to moderate-income households to invest in their future.

These low-interest, no-down-payment mortgages are specifically designed for individuals to buy the property of their dreams outside the rat race of the big city.

But they’re not perfect for everyone – and they come with more than one catch.

What is a USDA Loan?

Although you might not associate tractors and beets with homeownership, the United States Department of Agriculture’s mortgage program is one way the government “improve[s] the economy and quality of life in rural America.”

The first iteration was introduced in 1991 as the Single-Family Housing Guaranteed Loan Program.

This program was designed to boost homeownership rates in rural and suburban America among low- and moderate-income homebuyers.

Since then, various updates have expanded opportunities even further through the USDA Rural Development Guaranteed Housing Loan Program.

Depending on your specific loan, these government-backed debts can be used to purchase, construct, and renovate homes in eligible areas. USDA loans are unique among most mortgages in that they:

  • Offer low-interest rates even to buyers with lower-than-perfect credit scores
  • Don’t require a down payment
  • Can have repayment terms up to 38 years for eligible applicants
  • Have capped upfront fees and PMI

But to qualify for a USDA loan, you must meet specific terms and conditions.

How Does a USDA Loan Work?

USDA loans are mortgages either backed or handed out by the USDA, meaning that the government will cover the debt in case of default.

These loans go to low- to moderate-income families under one of two primary programs:

  • Single-Family Housing Direct Home Loans: Provide assistance to low- and very-low-income applicants to repay their mortgage. The USDA funds these loans directly (hence the name “direct home loans”) for Americans who can’t access financing for adequate housing by other means.
  • Section 502 Guaranteed Rural Housing Loans: These go to low- and moderate-income applicants who want to purchase homes in eligible rural and suburban locations. Qualified applicants may receive up to 100% financing (read: no down payment required!) as long as they meet income and geographic limits.

Qualifying for a USDA Mortgage: What are the Requirements?

USDA loans are designed to go to individuals and families who can’t access “decent, safe, and sanitary housing” by traditional means.

Applicants have to meet certain requirements, such as being legally eligible to sign for a loan and participate in federal programs. Other strings include:

Location

Homes financed by USDA loans must reside within eligible rural or suburban areas, usually defined as regions with a population at or below 35,000. The USDA provides a map so you can check eligibility by address.

It’s also important to note that the USDA doesn’t designate a blanket mortgage limit. Instead, the maximum mortgage amount varies according to the cost of housing by location.

For instance, homebuyers in some parts of California may qualify for mortgages up to $500,000 or more, while buyers in the rural Midwest may see mortgage limits as low as $100,000.

Income

Because the cost of living varies from region to region, income limits are set based on where you live and your household size. Typically, you must:

  • Have an adjusted income within 115% or less of the low-income limit for the area
  • Bring in a dependable income (self-employed individuals can qualify with a history of regular cash flow)
  • Be able to show you can make your mortgage payments without incident for at least 12 months

The eligibility map above also provides location-specific income requirements based on your household size and county.

Credit Score

The USDA requires that applicants have a clean credit history for at least 12 months – in other words, no accounts that have gone to collections.

The program may make exceptions for individuals with marks caused by temporary or emergency circumstances, such as medical debts.

Additionally, applicants with a credit score of 640 or higher receive streamlined processing, while lower credit scores carry more stringent underwriting standards.

Those without a credit history may qualify with “nontraditional” references such as a history of on-time rental and utility payments.

Residency

The USDA requires that applicants hold citizenship or eligible non-citizen statuses, such as being a non-citizen national or Qualified Alien.

Types of USDA Loans

We looked at the two programs that issue USDA loans. But these loans also come in different flavors, so to speak.

Direct USDA Loans

Direct USDA loans are issued by the government for low- and very-low-income applicants. While thresholds vary, it’s not uncommon to see income limits of $17,000 per year or lower.

Direct USDA loans go to borrowers who can’t access financing any other way and are without adequate residence.

As such, they may carry interest rates as low as 1% for borrowers with credit scores hovering around 640.

Because of their special terms, USDA loans come with strict requirements on a person’s residence and income, such as:

  • Homes under 2,000 square feet
  • Properties with market values below the area’s loan limit
  • A total monthly debt-to-income ratio of 41% or below (including the mortgage payment)

Note: your debt-to-income ratio is how much of your monthly income goes toward paying your debts, including your mortgage, credit card bills, and other payments.

USDA Home Improvement Loans and Grants

USDA Home Improvement loans and grants are financial awards for low-income homeowners who need to repair or upgrade their homes.

This program may combine loans and grants for up to $27,500 in assistance.

Guaranteed USDA Loans

Guaranteed USDA loans guarantee, or back, a mortgage issued by a participating lender, similar to how FHA and VA loans work.

These USDA loans allow homeowners to access low-interest rates even at 0% down – though you may have to pay the USDA’s “mortgage insurance” fees of:

  • 1-2% of the total loan amount, plus
  • 0.35% annually for the life of the loan

What are the Rates and Terms for a USDA Loan?

With a traditional mortgage, you can expect to pay fixed interest rates around 3-5% of the home’s value based on your employment history, credit score, and financial situation.

But qualified USDA borrowers may receive loans for as little as 1% interest. And while the USDA doesn’t eliminate closing costs, they rarely exceed 1-3% of the total amount. Moreover, unlike some traditional mortgages, you can cover your closing costs with gift money.

When it comes to terms, most USDA loans come with a fixed-interest 30-year repayment plan. However, very low-income borrowers may be eligible for loan terms up to 38 years.

How Do I Apply for a USDA Loan?

Applying for a USDA loan is usually fairly simple. How long the process takes ranges based on fund availability, loan demand, and credit score, though the USDA processes applications in the order they’re received.

To get started, you can use the USDA map to view eligible regions, loan income limits in those areas, and other requirements.

Then, you can apply for a USDA Direct Loan via the USDA Rural Development Office. Prepare to provide:

  • Proof of citizenship or legal resident status
  • Your last two years of pay stubs and tax returns
  • Documentation of your bills and financial obligations
  • Your credit report or records of alternative credit history (such as rent or utility payments)

If you’re applying for a USDA Guaranteed Loan, you’ll need to reach out to a USDA-approved lender in the area you want to live.

The lender will process the application through the USDA. To find an eligible lender, you can go through a real estate agent or visit the USDA Rural Development site.

Advantages of USDA Loans

Opting for a USDA loan may offer better advantages than traditional or even other alternative loans if you’re eligible.

Low Origination Fees

Most USDA mortgages come with a 1-2% upfront fee that can be rolled into your loan.

No Minimum Credit Score

USDA loan programs don’t mandate a minimum credit score. However, if your score is nonexistent or below 640, you’ll need to demonstrate the ability to repay the loan.

Zero Down Payment

Borrowers don’t need to provide a down payment on USDA loans, which removes a crucial barrier for many low-income would-be homeowners.

Lower Rates

Rates on USDA loans typically fall below rates offered by conventional, FHA, and VA loans – even to borrowers with poor credit histories.

Easy-to-Refinance Loans

Individuals who want to refinance their loans can utilize the USDA’s streamlined refinancing process on existing mortgages.

This process often involves no home appraisals, credit reports, or even property inspections.

>> More: How to Refinance Your Mortgage

Disadvantages of USDA Loans

However, USDA loans also come with certain drawbacks that you may not encounter with other types of mortgages.

Income Limits

Borrowers must meet income requirements based on where they want to buy a house – not necessarily where you currently live.

Location-Dependent

USDA mortgages only cover homes within eligible suburban or rural areas, usually limited to populations of 35,000 or less.

USDA Up-Front Fee

USDA loans come with an upfront fee of 1-2% of the total loan amount, amounting to thousands of dollars. However, you can also roll this amount into the mortgage itself to pay it down over time.

Primary Residence Only

USDA loans only cover a borrower’s primary residence, which rules out second homes and vacation properties. Additionally, homes may not be designed for income-producing activities.

USDA Loan FAQS

Now that we’ve covered the basics let’s look at some of the frequently asked questions about USDA loans.

Are USDA Loans Cheaper?

USDA loans tend to cost less than conventional and even other government-backed mortgages. For instance, there’s no down payment required, few upfront expenses, and closing costs may be covered with gift money. Even accounting for the upfront fees and 0.35% annual fee for loans with 0% down, you’re still likely to pay less than with other mortgages.

How Long Does It Take to Close on a USDA Loan?

You can usually expect a USDA loan to close within 40 days or less, though some circumstances may take considerably longer.

Do You Have to Pay Back a USDA Loan?

Yes! A USDA loan is just like any other mortgage – in other words, it’s not “free money.”

Is it Hard to Get a USDA Loan?

If you fall within the required parameters of getting a USDA loan, the process to apply and be approved isn’t difficult. But if you have a troublesome credit history, irregular income, or other higher-risk circumstances, obtaining a loan might be more difficult.

What Properties Can I Buy with a USDA Loan?

USDA properties must reside in a rural area, be 2,000 square feet or less, and have a market value less than the applicable loan area limit. Additionally, homes in these areas cannot be designed for income-producing activities or have an in-ground swimming pool.

Who Regulates USDA Loans?

The Rural Housing Services implements and administers loans, grants, and guarantees for rural housing services. Low-interest, fixed-rate loans are provided by USDA Rural Development.

Bottom Line: What is a USDA Loan?

USDA loans make purchasing a home more accessible and affordable for those living in qualified rural areas.

While you’ll still pay fees and closing costs, the low-interest rate and lack of a down payment make these loans more affordable than even other government-backed programs.

As such, for very-low- to moderate-income singles, couples, and families, a USDA loan can make securing your dream country home more affordable than ever.

Jordan Blansit
Jordan Blansit

Jordan Blansit is a Senior Writer, Researcher, & Product Analyst for SimpleMoneyLyfe with an inexplicable predilection for mortgages, investing, and personal finance. When she’s not click-clacketing from the comfort of her living room, you can find her in the California Redwoods or Oregon Siskiyous. Jordan’s areas of expertise are mortgages, personal loans, credit cards, and investing.