What is a USDA loan, and am I eligible?

What is a USDA loan?

USDA loans encourage homeownership for people in rural communities who have trouble qualifying for other, more traditional mortgage loans. Loan funds can be used to purchase or renovate a house in a rural or suburban area, or to refinance an existing home loan.

The USDA Rural Development’s housing program guarantees single-family housing loans for low- and moderate-income earners in rural areas. “Guarantee” doesn’t mean that every applicant will qualify, but rather that the USDA will reimburse lenders if a borrower defaults on the loan. Because the government takes on all the risk of the loan, lenders are able to offer low-interest rate loans, even without a down payment.

How does a USDA loan work?

You can get a USDA loan from private banks and mortgage lenders. Unlike traditional mortgage loans, to be eligible for a USDA loan, you must meet certain qualifications relating to your income and location, and the home for which the loan is issued must be owner-occupied. All USDA loans come with 15- or 30-year fixed rates.

Before you can be approved for a USDA loan, a lender will evaluate your credit history and repayment patterns to determine if you’re eligible. Eligible homebuyers can qualify for up to 100% financing, meaning they \don’t have to make a down payment at all.

Types of USDA loans

USDA loan options include loan guarantees, direct loans and home improvement loans:

• Loan guarantees

  You can use a USDA loan guarantee to build, improve or relocate your home in an approved rural area. To be eligible for a USDA loan guarantee, you need a credit score of at least 620 and a debt-to-income (DTI) ratio less than 50%.

• Direct loans

  Low- and very low-income thresholds to qualify for a USDA direct loan vary by location, but typically you must make 50% to 80% of the average median income for your area. Federal subsidies make it possible for interest rates to be as low as 1%, and terms can last up to 38 years. Properties financed through direct loan funds must generally be less than 2,000 square feet and worth less than the loan limit for the area. The property cannot be designed for commercial activity or include an in-ground swimming pool.

• Home improvement loans

  Available until Sept. 30, 2023, USDA home improvement loans are available to low-income older adults for home repairs and improvements. Sometimes called 504 loans, these loans are available up to $40,000.

» MORE: USDA eligibility maps: what they are and how to use them

USDA loan income requirements

In 2023, the USDA increased income limits for loan applicants. For most rural locations, the gross income limit is $103,500, with larger households of five or more at $136,600. However, income eligibility requirements vary by area. The USDA defines “moderate income” as no more than 115% of the median family income in the United States, or 115% of the statewide average of medium incomes across counties.

Keep in mind that when the USDA evaluates a family’s income, it takes into consideration everyone in the household, not just the applicant or co-applicant. For instance, if your teenage daughter has a part-time job, you’ll have to disclose her wages as part of your household income. You will, however, receive credits for documented child care expenses, as well as expenses related to household members with a medical condition or elderly parents who live with you. You’ll be able to claim a $480 credit for every child under 18 and every child who is a full-time student, and you can claim a $400 credit for every adult in the household over 62.

USDA loan credit requirements

If your credit score is 640 or higher, your USDA loan application process will be streamlined. Keep in mind that lenders consider more than just your credit score. Even if your credit score is somewhere between 620 and 640, you could still qualify, but you’ll be required to meet other, more strict, underwriting standards.

If your credit score is below 640 and you have outstanding credit card balances, you should try to pay those down before you apply for a USDA loan. This will improve your credit utilization ratio, which represents the maximum amount of credit you have access to compared with what you are actually using. Getting your credit utilization ratio below 20% will increase your chances of qualifying for a USDA loan.

» MORE: FHA loans vs. USDA loans: 6 key differences

USDA loan property requirements

Typically, if a property is attached to a city ZIP code, it won’t qualify, but suburban areas outside of a major metro area could. The USDA’s property eligibility map provides the most complete information about eligible and ineligible areas for loans backed by the USDA.

Most people are surprised to find out what counts as rural. For example, Readington, New Jersey, is designated as an eligible rural area, and that’s only about 50 miles outside New York City.

Lorena Semerenko, a California-based Realtor, said there were many areas in her state that fell under the rural area, including some parts of Bakersfield, which has a population of over 400,000.

“Some of the areas that they consider rural don’t strike me as what would be rural in comparison to other areas,” she said. “But ultimately it is a great thing because it allows for more opportunities for lower-income buyers who do not have a down payment available.”

Homes purchased with USDA funds must be up to date regarding health and safety functions. The federal goal of the Single Family Housing Guaranteed Loan Program is “to provide low- and moderate-income persons who will live in rural areas with an opportunity to own decent, safe and sanitary dwellings and related facilities.” You won't be able to take out a USDA loan for a property that isn’t deemed “decent, safe and sanitary” by USDA standards.

The USDA requires that you live in the home you secure the loan for. This prevents people from taking out a USDA loan to invest in a property they won’t actually live in. The USDA also disqualifies working farms from loan programs.

Other USDA eligibility requirements

In a lot of ways, applying for a USDA loan is like applying for any other mortgage loan. You must prove your ability to repay, usually with pay stubs and tax returns, and also meet the USDA’s other eligibility requirements: Your income must be significantly less than the median income in your area, and the property you finance with a USDA loan must meet certain criteria.

USDA loans aren’t reserved for first-time homebuyers — anyone can apply. Since USDA loans were created for prospective homebuyers outside of urban areas who have trouble qualifying for more traditional mortgage loans, qualifying for a USDA loan is usually easier than qualifying for other mortgage loans. Other USDA loan eligibility factors include:

1. U.S. citizenship status

   USDA loans are available for U.S. citizens, U.S. nationals and qualified aliens or lawful permanent residents. To qualify for any USDA loan, you’ll have to prove your citizenship status with a government-issued photo ID, birth certificate, alien registration card or naturalization/citizenship certificate.

2. Maximum DTI ratio

   Most of the time, USDA loan lenders won’t accept an applicant with a DTI ratio greater than 50%. To calculate your DTI, simply add your monthly debt payments and divide the total by your gross monthly income.

   When evaluating your ability to repay, a lender will also take into consideration your PITI ratio, which stands for principal, interest, taxes and insurance, plus all other payments you’re obligated to make each month, including student loans, credit cards, vehicle payments and co-signed loans.

3. Meet USDA loan limits

   There is no maximum amount for a USDA-guaranteed loan. The limit to how much you’ll be able to borrow is determined by lenders based on your credit history, payment history, assets, savings, debts and income. USDA direct loan limits vary by county and are based on the median home price for that area.

4. Ability to make monthly payments

   When evaluating your creditworthiness, lenders will also consider job history, income and assets. You must be able to demonstrate that your monthly mortgage payment won’t exceed 29% of your monthly income. Most lenders will want to see proof of a steady income and employment for at least 24 months. You will not qualify for a USDA loan if you’ve been suspended from another federal program.

USDA loan pros and cons

Paying $0 down on a house with a fixed-rate loan over a long term sounds ideal for almost anyone. But there are some drawbacks to consider, as well, particularly relating to eligibility requirements and processing lengths.

USDA loan benefits

• $0 down payment

  USDA offers a mortgage program that lets you roll closing costs into the loan, which is why it’s possible to finance up to 100% of the home purchase, including upfront fees.

• Low, fixed rates

  When you get a fixed rate, you don’t have to worry about your rates increasing over time. All USDA loans are available over 15- or 30-year terms. As with other types of loans, opting for a shorter term will make your monthly payments higher, while a longer term will spread payments out over more time, resulting in a lower monthly bill.

• Cheaper mortgage insurance

  Most home loans require mortgage insurance to be paid monthly. Annual mortgage insurance premiums for USDA loans average only 0.3%, which is the lowest of any mortgage loan program (except for VA, which does not require mortgage insurance at all).

• Flexible credit standards

  Since USDA loans were created for people who can’t qualify for more traditional mortgage loans, lenders are more likely to accept applicants with spotty credit histories. Borrowers may be able to present alternative documentation, such as cell phone bills, to represent their payment histories.

• No early payoff or prepayment penalty

  The lender won’t penalize you if you make larger payments. If you’re able to, paying off a USDA loan early could be worth it. You’ll pay less interest on the loan over time, gain equity in the house more quickly and see a better return on your investment.

USDA loan disadvantages

• Strict eligibility and qualification requirements

  Eligibility requirements are factors like the location of the property you want to buy and income limits for that area. Qualifying requirements have to do with your credit history, DTI ratio and ability to repay.

• Restrictive access

  Even when you’re approved for a USDA loan, you can only use those funds to purchase a home in designated “rural” areas. Sometimes real estate agents don’t have a firm grasp on these boundaries, so you risk wasting your time touring homes and placing bids only to realize the property is a few blocks away from an eligible rural area.

• Longer approval process

  It takes longer to get approved for a USDA loan than an FHA or conventional loan. A home seller might decide to sell their house to a buyer who doesn’t have to wait a long time to get the final stamp of approval.

Bottom line: Are USDA loans worth it?

If you’re a prospective homebuyer earning less than a moderate income in a rural area, then a USDA loan could be a great option for you. If you meet USDA loan requirements, you’ll pay very little or $0 down on a house and get access to a low, fixed interest rate over a 15- or 30-year term.

Remember, applying for a USDA loan is a lot like applying for any other mortgage loan. You must prove your creditworthiness, plus meet the USDA’s other qualifying requirements: Your income must be less than the median income in your area, and the property you finance with a USDA loan must meet certain criteria. The only way to confirm you meet the income and property requirements for a loan guarantee from the USDA is to consult the USDA property eligibility website. If you are eligible for a USDA loan program, the site will direct you toward the correct application process.