USDA loans are a government program that provides low to middle-income borrowers with 100% financing. If you fit the income requirements, you can buy a home in a rural area with no down payment. Many people want to know if the USDA then charges mortgage insurance or PMI on the loan, like conventional loans charge.
What is Private Mortgage Insurance?
Private Mortgage Insurance is insurance for the lender. Yes, you pay the premium, but the lender gets the coverage. If you stop making payments on your loan, the insurance will help reimburse the lender for the loss they take on your defaulted loan.
Typically, PMI is only for conventional loans. Borrowers that put less than 20% down on a home must pay PMI. They are required to pay for this insurance coverage until they owe less than 80% of the home’s value. USDA loans don’t charge PMI.
What USDA loans do charge, however, is annual mortgage insurance. The idea is the same – the insurance protects the lender should you default, but the similarities end there.
How USDA Mortgage Insurance Works
The first charge you’ll see with a USDA loan is the upfront guarantee fee. This fee is a percentage of your loan amount and should be paid at the closing. Right now, this fee is 1% of the loan amount. If you can’t pay it at the closing, you may be able to wrap it into your loan amount.
The second USDA insurance charge is the annual guarantee fee. This is the fee that is similar to PMI, but it is generally much lower than actual PMI. Right now, the USDA charges 0.35% of the outstanding loan amount each year. The lender will charge the fee to you in 1/12th increments. In other words, you pay 1/12th of the amount each month.
On a $150,000 loan, you would pay:
- Upfront fee – $1,500
- Annual fee – $43.75/mo or $525 per year
How to Qualify for a USDA Loan
USDA loans aren’t for everyone. Even though it sounds perfect to get 100% financing and have low insurance rates, you have to qualify by being a low-income borrower. The USDA has specific income guidelines you must meet in order to qualify. In fact, you can make too much money and not qualify for USDA financing. It’s meant as a ‘last resort loan.’ If you qualify for any other type of financing, you would be ineligible for USDA financing.
That being said, you must meet the following guidelines to get a USDA loan:
- 640 credit score
- 29% housing ratio
- 41% total debt ratio
- Stable income and stable employment
- The home must be located in a rural location
- The home must be ‘modest’ for the area
- You cannot have any federal defaulted loans
The main difference between the USDA guarantee fee and the conventional loan PMI is how long you pay the fee. By law, the lender must cancel PMI once you owe less than 78% of the home’s value. There isn’t a law that states anything about the guarantee fee. Because of this, the USDA can charge the guarantee fee for the life of the loan.