If you are thinking about taking the steps to buying a home or buying land to build a house, you are probably experiencing a lot of joy, excitement, and anxiety. Planning your next move can be both a rewarding and exhaustive endeavor. Envisioning your family in a new home, searching properties online, determining what purchase price you can afford, figuring out how you can make it all work…the list goes on and on.
One of the most critical parts of moving, but perhaps not the most exciting, is securing financing for your new place. Most people know about conventional loans and FHA loans, but there’s another loan that many homebuyers often overlook. For qualifying borrowers, a USDA loan can be an excellent option.
USDA Loans Defined
Backed by the U.S Department of Agriculture, a USDA loan is a mortgage geared toward potential homeowners who may not otherwise be able to secure a loan. USDA loans also focus on rural areas instead of cities and more urban locations.
USDA loans are government-backed mortgages, much like FHA loans. This means the government insures the loan, making it less risky for a mortgage lender to approve it. Mortgage lenders like banks and credit unions issue the loan, not the U.S. Department of Agriculture. This government department simply guarantees the loan, so the lending company that issues the mortgage does not lose all of its money if the borrower defaults on the loan.
This type of loan is called a non-conforming mortgage, which means it’s not a conventional mortgage. Conventional mortgages are backed by Fannie Mae or Freddie Mac. An FHA loan is another example of a non-conforming loan, as it is backed by the U.S Department of Housing and Urban Development.
One of the great benefits of USDA loans is that they require no down payment. Down payments are usually between 5 and 20 percent of the purchase price for conventional loans. In addition, there is no minimum credit score. Many homebuyers wonder, “what credit score is needed for buying a house?” As they research options, they will find that USDA loans are one of the only mortgages with no minimum credit score.
The backing of the U.S. government and the low minimum requirements for securing a USDA loan makes this option very appealing for many Americans looking for their next home.
Am I Eligible For A USDA Home Loan?
That sounds like a pretty great loan, right? So why doesn’t everyone use USDA loans? Well, there are some requirements that you need to meet to qualify for this type of loan. These requirements are tied to two key factors: Household income and the property's location.
Household income requirements vary by location and present a bit of a quandary for some borrowers: There is a “sweet spot” household income for eligibility that can’t be too high or too low. While you need to be able to show that you have the financial means to repay the loan, you also need to show a household income of less than 115 percent of the median income in the area you are moving to.
For example, the income limit for USDA home loans in Napa, California in 2021 was $135,250 for a 1 to 4-person household. For a 5 to 8-person household, the limit was $178,550. By comparison, the income limit for USDA home loans in Duluth, Minnesota in 2021 was $96,300 for a 1 to 4-person household. For a 5 to 8-person household, the limit was $127,100.This first step to determining your eligibility is to find the income limits for the specific area or areas you are thinking of moving to. To see if you are eligible in the area you are looking to buy or build, use this USDA Eligibility Check Worksheet to find out.
The second part of eligibility has to do with location. USDA loans are also called “ USDA rural development loans.” One of the intents of USDA financing is to promote owning homes in underdeveloped parts of the country. This might make you think only large swaths of farmland are eligible, but that’s not the case.
Contrary to popular misconceptions, you are not required to purchase large pieces of land and work in the farming industry to secure a USDA loan. The area can’t be very densely populated like a big city, but it doesn't necessarily need to be “in the middle of nowhere” either.The next step is to determine the eligibility of a specific property before moving forward with a real estate transaction. USDA home loan program eligibility might influence the amount you can offer for a particular home, so see if it’s eligible first. To see if a property is eligible for a USDA loan program, search this USDA Eligibility Map.
Kinds Of USDA Loan Closing Costs
Now that you understand what USDA loans are and if you might be eligible, let’s dive into the closing costs. These can be divided into two categories: Loan and property costs.
USDA Loan Costs
USDA loan costs come in lender fees and can vary depending on which USDA mortgage lender you choose. USDA buyers usually can expect to owe title search fees, credit report fees, underwriting fees, origination fees, appraisal fees, prepaid interest, and discount points. Here’s an in-depth look at the costs, including estimated amounts.
These represent standard fees associated with your loan, but your lender may charge other fees. Make sure they give you a complete cost breakdown before you close on your new home.
In addition to the lender fees you pay as part of your USDA loan, there will also be costs associated with the property itself. These include recording fees, prepaid property taxes, home insurance premiums, home warranty fees, and homeowners association (HOA) fees. Here’s an in-depth look at all the costs, including estimated amounts.
All of these fees can vary depending on the property's location, local tax rates, and the insurance company you choose. Do your homework and shop around to get the best price.
USDA Loan Closing Costs: How Can I Pay?
Now that you know what costs are associated with closing on your USDA loan, you may be thinking, “how can I pay for closing costs?” You might be delighted to know that you don’t necessarily need to come up with all that cash to cover closing costs. In fact, there are a variety of other ways you can pay for your USDA loan closing costs.
Roll USDA Loan Closing Costs Into Your Loan
If your new home appraises for a higher value than the sales price, your lender may let you roll your closing costs into your loan. This allows you to pay them over time, much like the principal and interest on your USDA loan. For this to work, the home must appraise for at least the home’s purchase price combined with your USDA home loan closing costs.
Seller Pays USDA Closing Costs
When you are negotiating with the seller on an offer for the property, you may be able to get them to pay all or some of your closing costs. By law, sellers can contribute up to 6 percent of the purchase price toward the buyer’s USDA closing costs. So, if you are buying a home with a purchase price of $100,000, the seller can pay as much as $6,000 toward your closing costs.
USDA Loan Closing Costs Assistance Program
Many assistance programs are available for potential homeowners to help with their USDA loan closing costs. These are often run by local government agencies or non-profit organizations. In some cases, they will give you the money in the form of a grant. In other cases, they will provide you with a loan that will be forgiven if you live on the property for a long enough period.
Gifts Can Cover Closing Costs
Family members, friends, co-workers, or employers can cover your closing costs as a gift. Before you close on your home, reach out to your social network if you have trouble figuring out how to pay for your USDA loan closing costs.
Lenders can waive some of their fees or offer credits toward your closing costs in exchange for a higher interest rate or principal monthly payment over the term of your USDA loan. If you are shopping around for lenders (which you should), be sure to let them know what each of them is offering to create some competition. This might end up getting you better loan terms and reduced closing costs.
USDA loan closing costs are a critical part of your calculations when determining your next move. While they can be extensive, there are many ways you can pay for them (or avoid paying them).
USDA loans offer great benefits like requiring no down payment or credit score, so don't let closing costs scare you away. As with anything, knowledge is power. Educate yourself on the USDA loan requirements, eligible locations, income maximums, and, of course, closing costs. It might be just what you need to purchase your next home.