Buying a house is a big financial decision. There is almost nothing better than living in a place that you call your own. And because housing values generally increase over time, you can think of it as an investment. But for you to buy a property, you should either have cash on hand or be eligible for a home loan, both of which can be challenging to get.
When applying for a loan from a traditional lender like a bank, you will have your personal and financial information scrutinized. If there is even one factor that does not meet their criteria, the lender might automatically decline your application. So how can you afford a home without increasing your income by a significant amount?
Government agencies like the USDA have loan programs that help first-time buyers with low-to-moderate incomes to purchase a home in a rural area. In this article, you will learn all about the USDA loan:
- What it is
- Who is eligible
- What are the USDA home loan closing costs
- How to pay for the USDA loan closing costs
What Is a USDA Loan?
A USDA loan is a mortgage program offered by the United States Department of Agriculture (USDA) through private lenders. It offers benefits for first-time homebuyers who want to purchase a home in a rural area, which is 97% of the country’s landmass.
This government program provides affordable homeownership opportunities to low-to-moderate-income households. The USDA hopes that by offering an affordable loan to homebuyers who wish to live in a rural area, they can stimulate the economy in these communities.
The USDA loan has a guarantee that allows lenders to take on more risk and offer eligible homebuyers better rates and terms. Here are some of the loan benefits that the program offers:
$0 Down Payment
The number one reason why many have not bought a home is that they are still saving up for the 5% to 20% down payment. Many families cannot even afford this.
The USDA loan is one of the last remaining $0 down payment mortgage options available. The one caveat is that you must buy a house in a rural area. Properties in cities and surrounding communities are not eligible.
Competitive Interest Rates
The USDA provides a guarantee to lenders so they can offer lower interest rates to home buyers who avail of this program.
Actual rates vary depending on the private lender, your credit score, and the current market conditions. But you will notice a difference when you compare the interest rates with those of conventional loans.
Low Monthly Mortgage Insurance
When you apply for a conventional loan but cannot come up with a 20% down payment, lenders will require you to pay for private mortgage insurance (PMI). This fee can range from 0.2% to 2.15% of your total loan that you will either have to pay upfront, per year, or per month. Depending on the lender, paying for your PMI ends once your loan-to-value ratio reaches 80%.
Meanwhile, the USDA does not require a PMI. instead, they will charge you with two fees:
- An upfront fee that costs 1% of the total financed amount, which you pay once you close on the loan or have it included in your total.
- Annual fee worth 0.35% of your loan’s current balance, which you can partially pay per month.
Flexible Credit Requirements
Most conventional lenders require you to have a credit score of at least 640 to apply, but you need to have about 720 or higher to qualify for lower interest rates.
USDA does not require a minimum credit score for you to qualify for a loan. If you have a credit score of 640 or higher, you can get your loan processed faster since the lender will qualify you using an automated underwriting system. But if your credit score is below 640, you can still qualify for a USDA loan. However, processing your application will take a longer time as they will have to manually underwrite your loan.
Who Is Eligible to Get a USDA Loan?
The USDA created this program to help low-to-moderate-income homebuyers who otherwise could not afford a traditional down payment that ranges from 5% to 20% of the purchase price.
To qualify for a USDA loan, you have to meet both the USDA and the lender’s credit and income criteria.
The lender’s criteria may vary depending on the organization. Meanwhile, these are the USDA’s requirements:
- You must be either a US citizen or a permanent resident.
- You must have at least two consecutive years of consistent and dependable income.
- You must have the ability and willingness to repay your mortgage. This means that you have no late payments up to 12 months before your application.
- You must have an acceptable debt ratio, which can vary by lender and other factors.
- Your adjusted annual income must not exceed 115% of the median income in the area where you are buying a home, depending on the family size.
- The property that you wish to buy must be in a qualified rural area. It must also serve as your primary residence.
As for your credit score, the USDA does not have a minimum requirement for this. If you have a credit score of 640 or higher, then you will qualify for a USDA loan. Meanwhile, if your credit score is lower than this, you can still qualify, but processing your loan may take a longer time as it will require manual underwriting.
About USDA Loan Closing Costs
While the USDA loan can help you save money with the many benefits it offers, you will still have to deal with closing costs when purchasing your home. USDA closing costs go between 3% to 6% of the purchase price.
USDA loan closing costs pay for the same type of expenses that other types of loans do. These would include an appraisal, title search, title insurance, credit report fee, and more.
Fortunately, you can negotiate for the seller to cover part or all of your USDA loan closing costs, so try to include this concession in your contract of sale.
What the USDA Loan Closing Costs Cover
When you buy a home, you will encounter closing costs that are related to the loan process as well as fees that come with owning a piece of real estate. USDA loan fees and closing costs can vary by lender and other factors. For example, some lenders charge a fee for processing your loan.
Here is a breakdown of where your closing costs could go, which are categorized by whether or not they are related to your loan:
Breakdown of USDA Loan-Related Closing Costs
- Origination fee. This is what the lender charges to cover the costs of originating or creating your loan application.
- Processing or underwriting fees. This is what the lender charges for processing, approving, funding, and servicing your loan.
- Title insurance. This policy protects you and your lender against title-related claims to your new home. You are required to purchase for both you and your lender.
- Credit report fees. This pays the lender for checking your credit report and ensuring that you have paid your past debts on time.
- Appraisal fee. This determines the market value of the home you are purchasing to make sure that it is worth at least as much as you are paying.
- Discount points. This pays the lender in exchange for a reduced interest rate. They can help you determine if this is a financially wise move depending on your situation.
- Well-water test. If you are buying a rural property with a private well that is supplying water to the home, the USDA will require you to pay for a well-water test.
- Septic inspection fee. If the property you are buying is not hooked up to the public sewer, the USDA will require you to have its private septic system inspected.
- Termite inspection fees. Depending on your state, county, or municipality, you might be required to have the home inspected before taking out a loan. Your lender will take care of this and other inspection fees on your behalf before closing the sale.
- 1% upfront fee. This serves as the USDA loan’s monthly insurance premium instead of getting a more costly PMI.
Breakdown of Other Closing Costs
- Prepayment of property taxes. You will usually have a prorated property tax payment due at closing.
- Homeowners insurance. Your lender will require you to pay the first year before closing the sale.
- Daily interest charges or prepaid interest. This is the amount of interest that you will owe for the days between your loan closing and the end of the month.
- Recording fees. This is a one-time payment to your county for making the purchase official and updating their public records to reflect the change in ownership of the property.
- HOA fees. If you bought a home in a neighborhood that has a Homeowners Association (HOA), you will have to pay these fees upfront.
- Home warranty. This is not a required expense, but it can cover a wide range of house-related expenses that are not covered by your homeowner’s insurance.
- Property survey fee. The USDA does not require this, but you could ask for a professional to confirm the property’s boundary lines and legal description. This is especially helpful if you are buying a house with a big lot size.
- Transfer tax/deed stamps. Depending on which state you are in, either you or the seller will pay this fee.
- Flood certification. This verifies if the home you are buying is located in a flood hazard area.
- Escrow fees. This pays for the escrow account that you use to hold the funds that pass between you and the seller.
- Notary fees. This pays the professional who verifies the signatures of everyone signing the contract and other documents.
- Closing attorney fee. The closing attorney takes care of all arrangements necessary to close the lender’s mortgage transaction.
How to Pay for USDA Loan Closing Costs
There are several ways to pay for your USDA loan closing costs.
#1: Have the Seller Pay for It
If the seller you are dealing with wants to sell their house quickly, you may get them to agree to pay the closing costs in the form of a “seller credit.” You will have to negotiate with them to get this included in the contract. They can pay up to 6% of the purchase price toward your closing costs.
#2: Finance Your Closing Costs
You could also finance the closing costs into your loan. However, this is only possible if the home you are buying is appraised for more than the purchase price.
#3: Have Your Lender Pay for It
If the first two options will not work for you, then you could ask your lender to pay them for you. However, you might end up getting a higher interest rate. This is because your lender will get a rebate on the new higher interest rate, and they will use some of the proceeds to pay your closing costs.
If all else fails, then you will have to pay these costs at closing.
Getting a Home Loan Is Now a Little Bit Easier
The USDA loan program has made it easier for aspiring homebuyers who have low-to-moderate income and cannot afford the traditional down payment to purchase their first home. While you may still need enough funds to deal with the USDA loan closing costs, there are other options you can look into before paying them yourself. You could:
- Have the seller pay for it;
- Finance your closing costs; or,
- Have your lender pay for it.
Now that you know what a USDA loan is and how it can help you buy your first home, it is time to go house hunting. You can use an online platform like Mashvisor’s Property Search to find homes that are eligible for a USDA loan. Use the map view to find your desired neighborhood and browse the many active listings on our database.
To get access to our real estate investment tools, click here to sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.