USDA loans are one of the least recognized loans available to consumers today, yet they provide the most benefits. It is true that these loans are only available in areas considered rural, but the USDA has a broader version of rural than most people would assume, making it a readily available program for more people than they realize. The USDA determines whether or not an area is rural based on its population reported on the census. You can quickly determine if your area is rural by going to the USDA website and searching their map to determine if you are eligible for a USDA loan.
No Down Payment
One of the largest benefits of USDA loans is the ability to obtain 100 percent financing. If you do not have any liquid assets to help you pay the closing costs, you may also have the advantage of rolling your closing costs into the loan. This will make your loan-to-value higher than 100 percent, but the USDA offers this program for those that have difficulty getting into a mortgage yet want to be homeowners. The goal of the program is to provide proper housing for those that would otherwise be unable to afford their own home. They do not focus on how much money you make – in fact, they have maximum income guidelines that prevent anyone that makes too much money from using the program. It is strictly a program for those with low to mid-range income.
The Different Areas of the USDA Map
The USDA does not have a standard loan maximum like the national conforming limit of $417,000 on conforming loans. Every area of the country has a different limit. The USDA determines these limits based on the cost of the living in the area combined with the typical home price in that area. In fact, each county in the same state has a different limit. The USDA changes these limits often, which is why it is important to have up-to-date information on your USDA loan process and what you are eligible to receive. The actual areas that the USDA approves for USDA financing changes periodically as well, although not as often as the loan amount maximums change; using a lender that stays informed on the changes is crucial to your loan’s success.
Once you know the home you wish to purchase is eligible for USDA financing, you have to take a look at your financial profile to see if it qualifies. The standard issues that you face with any loan type pertain to this loan type as well, with just a few alterations:
- Your gross monthly income
- The amount of your monthly debts
- The amount of your assets
- Your credit score
- The appraised value of the home
The USDA has easier qualification guidelines for each of the above qualifying factors. Understanding the differences can help you determine if it is a loan program that would work for you.
USDA Credit Score Requirements
Generally, the credit guidelines are less stringent than other loan programs, but you should know that the USDA does put a lot of emphasis on a person’s credit history rather than the score. At first glance, however, the lender must qualify you based on your score simply to determine your eligibility as well as the level of scrutiny the file must undergo. A credit score lower than 580, will render you ineligible for the loan program altogether, but a credit score between 580 and 619 will provide you with eligibility with the contention that you undergo more scrutiny. If your credit score falls within this range, all of your qualifying factors must fall within the range stated by the USDA without exception. One very important stipulation put in place for borrowers with a credit score within this range is the inability to obtain a USDA mortgage if you do not have adequate housing history. Typically, a lender looks at a 12-month history either with a mortgage or with a rental history provided by the landlord.
If you are among the lucky borrowers with a credit score over 620, however, it is a whole new ball game for you with USDA loans. Lenders have the ability to look over any credit issues reporting as long as they are not consistently appearing on your credit report. In addition, with a credit score over 620, your housing history does not matter. What this means is if this is your first home purchase and you do not have a rental history, you can still obtain a USDA loan. You should be aware, however, that there is one type of debt that no loan program can overlook – federal debt. If you owe back taxes or have a federal lien on your credit report, you must pay it before applying for a USDA loan as is the case with FHA and conforming loans as well.
Once a lender determines that your credit score is above 620, he can look at a few sample things on your credit report in order to determine your eligibility. The lender’s focus is on the number of late payments you had in the last 12 months for both your general credit history as well as your housing history. If you have more than one late payment on anything except housing, you will not be eligible for a USDA loan; however, the lender will go back 3 years on your housing history – if you have more than 2 late payments in that time, then you are ineligible. If you suffered a bankruptcy or foreclosure, you must wait 3 years before you can apply for a USDA loan and if you have any collections, you need to pay them off or have some type of arrangement with the creditor. The exception to this rule is if the collections are federal or state government debts – you must pay any collections of that nature before you can obtain a USDA loan.
As is the case with other loans, if you had special circumstances surrounding the reason for your late payments, you might be able to get an exception. You will need ample evidence for that special circumstance; however, you cannot just say you lost your job because your company closed. You have to provide evidence of the company closing and your subsequent layoff. You will also have to provide evidence that you were able to pick up the pieces and pay your bills on time once you got your income back in line.
Debt Ratio Requirements
Debt ratios are something the USDA looks at closely when evaluating a loan application. The idea behind this loan program is to provide affordable financing for low-income families, which is why they monitor the debt ratios so much. Generally, you cannot have a front-end debt ratio (your principal, interest, taxes, and insurance) higher than 29 percent of your gross monthly income and your back-end ratio (all other debts plus your total mortgage payment) cannot be higher than 41 percent of your gross monthly income. The back-end ratio includes all debts that have 6 months or longer remaining on the debt. It also includes any payments you deferred, such as student loans. The lender will use the payment reporting on your credit report for qualification purposes.
If you have a debt ratio higher than 29/41, you may be eligible for an exception, but you must show compensating factors. These factors are those that make your loan file more attractive and less risky. Generally, the best compensating factor is a lot of liquid assets on hand, but since this loan is for low-income consumers, that is generally not plausible. Other compensating factors the USDA accepts include job consistency; high credit scores that show financial responsibility; and no collections or late payments reporting on your credit report, not only now but in past years.
Your income plays a vital role in your eligibility or USDA loans. Not only do you need to make enough to cover your financial obligations and have money for day-to-day living, but you cannot make too much or you become ineligible for the USDA program. Lenders verify your income the standard way with your current pay stubs that cover one month of income, your last 2 years’ W-2s, and your tax returns if you are self-employed. If you receive any other type of income, such as disability or social security, you will need to provide the award letter as well as a letter proving the continuance of the income for at least 3 years in order to qualify.
One area the USDA differs from many other loan programs is their use of part-time income. As long as you held the part-time job for the last year, you can include the income. They also allow pay raises that will occur in the next two months as long as you have proof of it in writing from your employer, and they also allow child support income as long as you have proof of receipt for the last 12 months and the proof it will continue for 3 years.
USDA Income Eligibility Guidelines
Because USDA loans are for low-income families, you must determine where your gross monthly income lies compared to the USDA requirements. If you know your area’s median income, you will know right away if you will qualify for a USDA loan as you cannot make more than 115 percent of the median income for your area in order to qualify. The income the USDA uses to qualify you is not your gross income, however. It is the income calculated after the USDA allowances are subtracted from your gross income. Your adjusted income gets calculated as follows:
- If you have a dependent child living with you, you can deduct $480 from your gross income for each child
- If you have a disabled family member that resides with you that is not on the loan, you get a $480 deduction
- If you have any full-time students over the age of 18 living with you, you can deduct $480 for each student
- If you have anyone over the age of 62 that lives with you, the lender can take a $400 deduction off of your income
Once you deduct all of the adjustments from your gross monthly income, you have your adjusted income, which the lender uses to qualify you for the loan.
USDA Mortgage Insurance
Like FHA and VA loans, the government guarantees USDA loans. This means that they pay the lender for your loan if you default on it. In order to do this, however, they need to charge mortgage insurance which they put in their reserves to pay for defaulted loans. There are two ways you pay mortgage insurance on a USDA loan.
- Upfront USDA mortgage insurance – You pay this fee of 2 percent of the loan amount, at the closing, but if you do not have the available cash, you can roll it into your loan.
- Annual USDA mortgage insurance – You pay this insurance on a monthly basis, as the annual fee gets divided into 12 payments. The amount charged is 0.4 percent of the loan amount.
Closing Cost Requirements
Closing costs are not easily negotiated on any loan type, whether it is FHA, VA, USDA, or conforming. There is certain costs the lender and title company incur in order to process your loan that you must pay. You can shop around with several lenders before you decide on one in order to save a little money, but generally, lenders charge the same fees such as processing, underwriting, credit report, appraisal, title search, title insurance, appraisal, document fees, and origination fees.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.