A USDA loan, sometimes referred to as “rural housing”, is one of the most powerful lending options available outside of a VA loan because it is the only other program where you can purchase a home with zero money down. Designed to help first time home buyers purchase a home without a down payment, you would think just about everyone trying to buy their first home would be getting a USDA loan, right? Wrong. There are three main limiting factors that tend to prevent the very people it could help most from being able to get a USDA loan. The first is location, the second is debt to income ratios (DTI), and the third is income.
USDA loans are often referred to as rural housing because USDA loans have to be in approved areas, and those areas are all rural. Each property address has to be checked to see if it is approved for a USDA loan. It is not uncommon for half a street to be eligible and the other half to be ineligible. So it is very important if you qualify for USDA financing that you let your loan officer know the address of the property you’re looking at.
The second challenge is DTI. There is a top end DTI and a bottom end DTI; one is without your new mortgage, and the other is your DTI calculated with your new mortgage. Without your mortgage, your DTI cannot exceed 29% and with your mortgage added in, your DTI cannot exceed 41%. This is a HUGE limiting factor and probably the number one reason why new home buyers have to go FHA instead of USDA.
And the third reason I’ll mention here is income. Believe it or not, a person or family can make too much to qualify for a USDA loan because there are income limits based on census tract. And unlike other programs, every person in the household, even if they are not on the loan, must be included in the income cap calculation. There are deductions for disabilities and other factors, but I can work out the calculation for you during prequalification if your DTI ratios fall within the lending parameters and you’re looking in a USDA eligible area.
USDA loans also have to be approved by the state USDA which adds time to your loan process. Your loan is essentially being underwritten twice; once by the lender, and once by USDA. Your loan must be cleared to close before it will go to USDA, so by the time it gets to the USDA it should be more like a review for them. Many lenders take a long time for USDA loans (up to 60 days), but I have several top government lenders who can get a USDA loan underwritten and closed in around 30-45 days without a problem. I’ve even done a few in less than 30 days.
Because USDA loans are backed by the government, they do carry up front mortgage insurance like an FHA loan as well as monthly mortgage insurance. In October 2016 the government heard the complaints of loan officers and lenders about how difficult it was to qualify for a USDA loan and lowered the up front mortgage insurance from 2.75% of the loan amount to just 1%, and the mortgage insurance was reduced from .5% monthly to just .35%. This was a huge move designed to help potential home buyers fit in the DTI ratios.
The last thing I will mention here about a USDA loan is that the appraisal is also somewhat tricky. Not unlike FHA or VA loans, the home must be in good shape so I would recommend avoiding a “fixer upper” if you are going with USDA financing. If the appraiser determines that repairs are needed, or something about the home does not meet USDA guidelines, then they will turn in the appraisal with an appraised value but “subject to” completion of anything they found wrong. That means the seller has to address it or you have no loan. Period. And once the seller does address the issue, you as the borrower then have to pay an additional $75-$175 to have the appraiser go back out to the property and check to make sure the issues were indeed properly addressed before finishing a “completion report” to close out the appraisal. Don’t let this overly concern you; it sounds worse than it really is. Just be aware that as with any government loan, it is possible your appraisal will come back “subject to” some item and will need to be addressed. It’s designed to protect the borrower (you), and ensure your home meets a specific standard. So although it may cost you time and a little more money for the appraisal if this happens, it’s certainly better to get it addressed before you buy it.