How to Qualify for a USDA Loan

The U.S. Department of Agriculture (USDA) provides guaranteed and direct loans to potential homebuyers who are income-eligible and plan on buying a home in a rural or suburban area. These loans have a low credit score requirement and some applicants don’t need to make a down payment, so they’re easier to qualify for than conventional, FHA and other loan options — especially for first-time homebuyers in today’s tough real estate market.

Here’s everything you need to know about USDA loans and how to qualify for one.

What is a USDA loan?

USDA Rural Development loans provide affordable financing to buyers who meet specific income eligibility criteria and plan to purchase a primary residence in a rural area, including some suburban neighborhoods. Guaranteed by the USDA (a federal agency), these loans often have a lower interest rate than conventional loans and, in some cases, don’t require a down payment. USDA loans can also be used to refinance an existing guaranteed or direct USDA loan in eligible areas.

Types of USDA loans

Private lenders provide most USDA-backed loans, but the Department of Agriculture offers some directly. There are three main loan programs you can look into:

Guaranteed USDA loans

This single-family housing guaranteed loan program allows approved mortgage lenders to provide 100% financing to low and moderate-income borrowers who plan to buy, build, remodel, relocate or improve a home in eligible rural areas. You can visit the USDA’s eligibility map to determine if the property you’re interested in qualifies.

There are no loan limits, meaning there’s no cap on how much money you can borrow, and the USDA will guarantee up to 90% of the loan amount, making it possible for a buyer to put a minimal amount down or forego making a down payment altogether without having to pay for private mortgage insurance (PMI).

Direct USDA loan

This single-family housing direct loan is issued directly by the USDA and is geared toward low and very low-income borrowers who don’t qualify for a traditional mortgage and don’t have safe and sanitary housing. Direct loans provide payment assistance to temporarily reduce their monthly mortgage payment, making it easier for the homeowner to repay the loan.

Direct loans can only be used to buy a primary residence that is at or below the area’s loan limits. The loan limit for most areas in 2023 is $377,600, although it can be as high as $871,400.

Home improvement loans and grants

The USDA also provides loans to very low-income homeowners to repair, improve or modernize their homes. The maximum loan amount is $40,000 with a 20-year term and a 1% interest rate. Aside from the income requirements, the homeowner must occupy the residence full-time — that is, they can’t use the money to refurbish a second or income-producing property — and must be ineligible for affordable financing through private lenders.

Through this option, homeowners who are 62 years or older can get a grant of up to $10,000 to remove or repair health and safety hazards like a damaged furnace or electrical system. Grant repayment is only required if the homeowner sells the property in less than three years.

A homeowner can use a combination of a loan and grant to access up to $50,000 for home repairs and improvements as long as all requirements are met.

How does a USDA loan work?

The USDA loan program has two types of loans: those guaranteed by the government agency and issued by USDA-approved lenders, and those issued directly by the agency. Both options aim to help low to moderate-income families obtain safe and sanitary housing in rural areas (and a few select suburbs) in the United States. All of the loans are government-backed and provide families with a more affordable path toward homeownership.

Funds from the loans can also be used to build a new home, or repair or improve an existing home they currently live in. Homeowners can also refinance an existing USDA loan into a new USDA loan. Borrowers must meet specific income requirements, and the home’s location must fall within an eligible rural area.

Applications for a guaranteed USDA home loan are made through an approved private lender, while applications for direct USDA loans are made through your state’s rural development office.

Qualifying for a USDA loan

You must meet several criteria to establish income and property eligibility for USDA rural mortgage loans. These requirements, explained in detail below, dictate household income limits and home location.

USDA loan requirements

To get a loan application approved for a USDA-guaranteed loan, you must:

• Use the loan to build, purchase or improve a single-family home in an eligible rural area

• Have an income that doesn’t exceed 115% of the area’s median income

• Be a U.S. citizen, eligible non-citizen, permanent resident or qualified alien

• Not qualify for affordable financing through non-USDA channels

• Demonstrate ability to repay the loan

• Meet your lender’s monthly income and credit score requirements (most lenders ask for a credit score of at least 640)

If you’re unsure if your income meets the USDA eligibility standards, you can visit its website and check.

To get a direct loan from the USDA, you must:

• Meet the area’s income limits as set by the USDA
• Be a U.S. citizen, permanent resident or eligible non-citizen
• Not currently live in a “safe, decent or sanitary” situation
• Be unable to qualify for another type of mortgage
• Not be suspended or barred from participating in federal programs

Direct loans also have property requirements: the home must not be larger than 2,000 square feet and can’t be used as an income-producing property.

To qualify for a home improvement loan, you must:

• Own the home and use it as your primary residence

• Not be able to find affordable financing elsewhere

• Meet the USDA’s very low-income limit for the county the property is located in

USDA loans vs. Conventional loans

Both guaranteed USDA loans and conventional loans can be obtained from private mortgage lenders, but there will be significant differences in the amount of money you need to put down, the interest rate you qualify for, the fees you’re charged and the appraisal requirements. Here’s how the two loan types differ:

Down payment

You can finance up to 100% of the home’s purchase price with a USDA loan, so you don’t have to put any money down upfront. If you can afford to put money down, however, it can help you obtain a better rate and term on the loan. Unlike conventional loans, you don’t have to pay for private mortgage insurance (PMI), a policy that protects the lender if you default on the loan, even if you put 0% down.

A VA loan (guaranteed by the Department of Veteran Affairs) is the only other government-backed loan that doesn’t require a down payment. An FHA loan (backed by the Federal Housing Administration) requires a minimum down payment of 3.5%.

Conventional loans require a minimum of 3% of the sales price as a down payment, although most lenders recommend 20% down. If you pay only the minimum, you’ll have to also pay for PMI, which is typically rolled into your loan, increasing your monthly payment amount. A down payment of 20% or more eliminates the need for PMI.

Interest rates

USDA-guaranteed loans are exclusively 30-year fixed-rate mortgages. Because the Federal government guarantees these loans, the interest rate charged is generally lower than that on a conventional loan. How much lower, exactly, will depend on the lender’s credit requirements and your financial information, including your debt-to-income ratio, credit history and credit score. To find the best mortgage lenders, shop around, compare rates and terms and determine the best fit before committing to a financing company.

If you already own a home in a USDA-eligible area and currently have a USDA loan, you can apply for refinancing. You can find better rates and terms by shopping around for the best mortgage refinance companies.

Guarantee fees

Although those who qualify for a USDA loan won’t have to pay for PMI, they do have to pay guarantee fees, which include a charge of 1% of the loan amount, paid upfront at the time of closing, and an annual fee of 0.35% of the remaining loan balance, which is divided by 12 and included as part of your monthly payment. These fees serve the same function as PMI: they protect the lender from losing money if you default on the loan.

Conventional loans do not have guarantee fees but will charge PMI on any loan if you make a down payment smaller than 20%. PMI can be as high as 2% of the outstanding loan amount.

Both USDA and conventional mortgages require you to pay closing costs, which can range between 2% and 6% of the loan amount and include fees for loan underwriting, application, origination and title services, among other costs.

Appraisals

An independent appraisal determines the home’s fair market value and is one metric lenders use to determine how much they are willing to lend. To determine a home’s value, an appraiser will look at a minimum of three comparable properties sold in the area. Both USDA and conventional loans require an appraisal as part of the application process.

USDA loan benefits

There are several benefits for homebuyers and owners who follow USDA guidelines and meet eligibility requirements. The most critical advantages include:

• You’ll get up to 100% on a purchase loan, which means you won’t have to make a large, upfront down payment.

• You can qualify for a loan with a lower credit score than other loan types

• The interest rate on the loan will be lower than other loan types

• The interest rate on a home improvement loan will be 1%

• Low to moderate income families will be able to access affordable financing

USDA loan disadvantages

USDA loans do have some limitations. The biggest drawbacks include:

• Loans are limited to home purchases in rural and some suburban areas, which means anyone looking to buy property in a large metropolitan area won’t qualify for a USDA loan

• There are income limits to who can qualify for a USDA loan.

• Loans can’t be used to buy investment or income-producing properties

• The USDA direct loans have a loan amount limit