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By Aly J. Yale
February 4, 2021
Kiersten Essenpreis for Money

A mortgage program originally intended to revitalize rural communities may not be often-used, but it sure does have its benefits. USDA loans — which are mortgages guaranteed by the United States Department of Agriculture — come with zero down payment, reduced mortgage insurance costs and low interest rates.

Still, the USDA guaranteed just 137,000 loans in 2020. That’s up 38.9% compared to the year prior, but USDA loans accounted for a mere 0.4% of all mortgage activity last week.

The limited use is somewhat surprising given the widespread availability of these loans. According to Sam Sexauer, president of mortgage lending at Neighbors Bank in Columbia, Mo., about 97% of U.S. landmass is actually USDA-eligible. More than 100 million Americans live in eligible communities — many located 30 miles or less outside major metros.

“It’s often thought that USDA loans are only for farms or agricultural properties, but that’s not the case,” said Scott Fletcher, president of risk and compliance at Fairway Independent Mortgage, the top originator of USDA mortgages in the country. “USDA loans do not need to be for a farm or have a large acreage to be eligible.”

Far from it actually. Buyers can often use USDA loans in the suburbs — a place many have flocked since the pandemic began earlier last year.

“With COVID causing a rush to the suburbs, USDA loans are an excellent resource for financing a home,” said Wayne Lacy, branch manager and senior loan originator at Cherry Creek Mortgage in DeWitt, Mich. “They offer the lowest combination of private mortgage insurance and down payment of all loan options, and they make purchasing extremely affordable.”

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What are USDA loans?

USDA loans — often called rural housing loans — are insured by the U.S. government, more specifically the USDA. The loans were established in 1991 to grow and promote more rural communities, but a large swath of the country is actually eligible.

“The USDA’s definition of ‘rural’ is much broader than many would assume,” said Ed Barry, CEO of Capital Bank in Rockville, Md. “Homebuyers often jump to the conclusion that the neighborhoods or addresses they’re considering aren’t ‘rural’ in the traditional sense, so they don’t even realize a USDA loan can be an option.”

To determine an area’s eligibility, the USDA looks primarily at population. Currently, areas must have 35,000 or fewer residents.

Buyers can check local USDA availability by visiting the department’s property eligibility tool, plugging in an address, and viewing the USDA boundaries on the map. In general, areas shaded orange don’t qualify. These typically include big cities and their denser, more immediate suburbs.

A good example is the Houston metro. Though Houston proper isn’t eligible for USDA loans, many communities just 30 miles out are. This includes places like Cleveland, Crosby and even parts of Katy — the top town for inward moves during the pandemic, according to an analysis of USPS change-of-address data.

Why use a USDA loan?

If you’re buying in a USDA-eligible area, these low-cost loans are worth consideration. For one, they don’t require a down payment — and that can mean big savings right off the bat.

“The biggest perk of the USDA loan is that there is no requirement for a down payment,” Sexauer said. “Outside of the VA loan, USDA financing is the only 100% financing option available.” (VA loans are reserved only for active military members, veterans and their spouses, making them unavailable to the bulk of homebuyers. Still, the Department of Veterans Affairs guaranteed a record 1.2 million home loans last year.)

To get an idea of what a USDA loan could save you, consider conventional loans — the most popular type of mortgage on the market. At minimum, conventional loans require at least a 3% down payment, or $15,000 on $250,000 home. FHA loans require even more — anywhere from 3.5% to 10% depending on your credit score.

Thanks to their government backing, which reduces the risk taken on by lenders, mortgage companies are also able to offer lower rates on USDA loans than they can on other loan programs. Sexauer says the average rate for a USDA borrower currently ranges between 2.375% and 2.75%. Conventional loans averaged 2.92% last week, while FHA loans sat at 2.94%, according to the Mortgage Bankers Association.

Another feature of the USDA loan is its guarantee fee — the USDA’s take on mortgage insurance. Though guarantee fees are required on all USDA loans (even if you do make a down payment), the costs of these fees are much more affordable than the insurance charges on other loans.

Currently, the USDA’s upfront guarantee fee — paid at closing — clocks in at 1% of the loan amount. On FHA loans, the upfront mortgage insurance premium is 1.75%. If you were taking out a $250,000 mortgage, that’d be a difference of $1,875 just on closing day.

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Qualifying for a USDA loan

The first step to qualifying for a USDA loan, of course, is to buy in a “rural” area. But you’ll also need to financially qualify for the program. The USDA loan program is designed for buyers with low and moderate incomes.

Your household — which includes all adults, even those not on the loan — can’t make more than 115% of the area’s median income based on current earnings. In Katy, Texas for example, a family with two adults would need to earn $90,650 or less to qualify. In some higher-cost housing markets, the income threshold can go up to $295,000.

You will also need a decent credit score. According to Lacy, the minimum is typically 640, though some lenders may go down to 620 if you’re flush in cash reserves or have a particularly low debt-to-income ratio — meaning your existing loan payments don’t take up a huge portion of your monthly income.

Beyond that, simply staying on top of your bills and saving up a little cash can help your case.

“Homebuyers can improve their chances of getting a USDA loan by having a decent debt payment history and savings,” Lacy said. “Even though homebuyers may not need to use their own money for the down payment, they still need to pay closing costs, so having savings is always an advantage.”

Finally, you will also have to choose the right lender. Though the USDA insures the loans, they’re actually issued by private mortgage lenders — and only certain lenders are approved by the agency. (Even some of the largest lenders in the country don’t offer these loans.)

If you’re not sure of a USDA-approved lender in your area, the USDA has a long list to guide you. Always contact at least three companies to ensure you are getting the best mortgage rate. Because they’re a scarcely-used loan, USDA loan rates aren’t typically published online.

Heading to the ‘burbs?

The pandemic has brought on countless changes in the housing market, but one of the most notable trends? That’d be the shift toward more suburban locales.

“Many of those tied to the office pre-pandemic were hesitant to move to the suburbs because of the tradeoff — a longer commute,” said Ali Wolf, chief economist at Zonda, a housing market research firm. “Now, with more people spending time at home, there has been a priority shift. Buyers are looking at the many things the suburbs can offer, including a large kitchen, spacious backyard and more square footage, and are deciding the move is worth it.’

If you’re considering hopping on the bandwagon and leaving the big city, a USDA loan might help you do it — and save some money in the process.

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