What Is a USDA Loan? USDA Home Loans Explained

USDA loans are a type of mortgage loan designed for rural home buyers. These loans can allow borrowers who may not qualify for a traditional mortgage to buy a home.

Before you apply for a USDA home loan, there are some factors you should consider. If you’re eligible, buying your first home with a USDA loan can potentially be a wise decision.

If you’re considering USDA loans, here’s what you need to know about USDA loans and how they can play a role in smart financial planning.

What Is a USDA Loan?

A USDA loan is a type of mortgage loan offered by the United States Department of Agriculture. These loans are specifically designed for rural home buyers. Unlike traditional loans, which require a down payment and may come with higher interest rates, USDA loans offer more favorable lending terms for the borrower.

USDA loans are offered through the USDA Rural Development Guaranteed Housing Loans Program. Because these loans are backed by the USDA—thus making lenders feel more secure—buyers can be eligible for better loan terms. That being said, it’s important to keep in mind that there are limitations in terms of location and other USDA loan requirements you may have to meet to be eligible for USDA loans.

How Does a USDA Loan Work?

When you apply for a USDA loan, you have to choose which of the three programs you want to apply for: loan guarantees, direct loans, or home improvement loans and grants.

Loan guarantees work similarly to VA loans, where the loan is backed by an organization so borrowers are eligible for more favorable lending terms. The USDA guarantees these mortgages as long as they’re through a participating lender, so you can get a favorable interest rate even without a down payment. These loans can be especially helpful when you’re already dealing with rising interest rates.

Direct loans are mortgage loans that are issued directly by the USDA. These loans are typically reserved for home buyers with a low or very low income, which means buyers must fall below a certain income threshold to qualify for direct USDA loans. This income threshold varies by location, but interest rates on these mortgage loans can be as low as 1%.

Home improvement loans and grants give homeowners access to the funding they need to make home improvements. Grants are different than loans because they don’t have to be paid back, but home improvement loans and grants can potentially be combined into one single package to maximize your home improvement budget.

Location is one of the primary restrictions in terms of qualifying for USDA loans. According to USDA loan requirements, you can only use a USDA home loan to purchase a home in a rural location. This means that you can’t typically secure USDA loans to purchase homes in metropolitan areas.

It’s important to keep in mind that there are certain parts of metropolitan areas, including suburbs, that may still be eligible for a USDA home loan. You can use the USDA eligibility website to input your address and figure out whether the home you’re looking at is eligible for a USDA loan. You can also look at areas that were previously eligible, as well as income limits and income eligibility information.

Choosing the right location is just as important as making sure you have the credit score to buy a house, so take your time to find the right home. The location you choose will determine whether or not your home is eligible for a USDA loan, plus location is a major determining factor when it comes to home value and demand.

Benefits of a USDA Home Loan

There are a lot of reasons you might think about taking out a USDA home loan to purchase a home. It’s no secret that home loans can be expensive, and USDA loans can offer a more affordable alternative for some homebuyers. Below, we go into more detail about some of the benefits you might enjoy with USDA loans.

For starters, one of the best parts about USDA loans is the fact that you can secure a loan with a small down payment, or no down payment at all in some cases. The large down payment required with a traditional mortgage is a barrier to homeownership for many people, but you may be able to purchase a home with a USDA loan with no money down.

Because USDA loans are backed by the USDA, you tend to get more favorable interest rates from mortgage lenders. What this means is that you’re not paying as much in interest each month, which makes your monthly mortgage payment more affordable and saves you money in the long run. Anyone who knows how to create a budget knows how important it can be to save a little money here and there.

If you’re not able to qualify for a traditional mortgage due to your credit score, you may still be able to qualify for USDA loans. USDA loans have lower credit score requirements than traditional mortgages, making them more accessible for buyers who would typically face difficult barriers when applying for a loan.

Finally, you don’t need to carry private mortgage insurance on USDA loans because they’re backed by the USDA. This means you save even more money each month, helping you budget more money for your other bills.

USDA Loan Requirements

While there are some real potential benefits of USDA loans, there are also certain requirements you must meet in order to secure a loan. These requirements can vary depending on the loan you’re applying for, but basic USDA loan requirements include:

Applicant must be a U.S. citizen or legal permanent resident 

Credit score greater than 640 is the typical minimum requirement

Demonstrate stable income 

Applicant income must be less than 115% of the median income in the area where the home is located 

Home must be located in a qualifying area (rural areas or certain suburban locations)

Home must serve as a primary residence

Before you apply with a mortgage banker for a USDA loan, it’s important to consider the requirements you must meet in order to be eligible for the loan you’re applying for. You may want to talk to a financial advisor or qualified lender about USDA loan requirements.

USDA Loans vs. Traditional Mortgages

Deciding between USDA loans and traditional mortgages can be tough, especially if you’re in a position where you can easily qualify for either type of loan. Ultimately, it’s up to you to decide whether USDA loans or traditional mortgages are right for you.

With a USDA loan, you get favorable loan terms at the cost of flexibility. You don’t have the freedom to purchase a home anywhere with USDA loans, and that may be a problem for some buyers. There are also income limits that may act as a barrier to entry for some home buyers. That being said, USDA loans are a good way to secure funding to purchase a house with minimal money down and lower interest rates.

Traditional mortgages typically offer less favorable lending terms, but they’re more flexible than USDA loans. You can purchase a home anywhere you’d like with a mortgage loan, and there are no income requirements. Unfortunately, mortgage loans are difficult for some home buyers to secure because they have strict credit score requirements. Plus, you may not get the best lending terms until you go through the mortgage refinance process.

How to Apply for a USDA Loan

The good news is that applying for a USDA loan is a fairly straightforward process as long as you’re eligible. Here’s what you need to do to apply:

Get pre-approved: Getting pre-approved gives you a budget that you can use to shop for your home

Search for a home: Find an eligible home in a rural location that’s within your budget

Make an offer: Make an offer on the home and wait for a response from the seller

Get an appraisal: Get the home appraised to make sure you’re paying fair value for it

Secure final approval: Get the final approval from the USDA so you can begin the buying process

Close on your new home: Finish the process of buying your home and start preparing for the big move

Final Notes

If you’re having trouble securing a traditional mortgage or you want to save while purchasing a home in a rural area, USDA loans can potentially be a smart decision. With USDA loans, you can secure a home loan with no down payment, plus you can enjoy lower interest rates and other benefits.

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