The term USDA is typically preceded by the phrase “Grade A” and refers to a great cut of beef served at a restaurant. However, the United States Department of Agriculture (USDA) is responsible for more than assuring that quality meat is provided at local butchers and eating establishments. The organization also offers mortgage loans for a home purchase. Although some of these things may sound too good to be true, or even insane, all of the following facts about the USDA Home Loan program are 100% true.
Disclaimer: Before reading any further please understand one very important point. The goal of this article is not to cast a bad light on any other type of mortgage loan. There are lots of good mortgage loans available to a wide range of buyers. This article is simply showing some of the advantages of one type of mortgage, the USDA home loan. With that out of the way, let’s begin.
USDA loans offer some enticing benefits like zero down payments and more flexible credit requirements But before jumping in, it’s important to understand the potential drawbacks too While USDA loans can be a great option for eligible borrowers, they aren’t perfect.
Let’s explore some of the key disadvantages and “bad things” to keep in mind with USDA home loans
1. Income Limits
To qualify for a USDA home loan, your household income must fall within the program’s income eligibility guidelines. Here are the current income limits
- Households with 1-4 people: $110,650
- Households with 5+ people: $146,050
If your income exceeds these thresholds, you won’t be able to get a USDA loan. This restricts the program to low-to-moderate income borrowers.
So while higher earners may want to take advantage of the perks, USDA loans aren’t an option if your income is too high. You’ll need to explore other loan programs instead.
2. Property Location Restrictions
USDA loans can only be used to purchase homes in designated rural areas. Properties in cities, suburbs, or urban locations won’t qualify.
The USDA uses population data and density metrics to determine eligible locations. In general, small towns and rural communities are more likely to meet requirements than larger metropolitan areas.
This geographic restriction limits choices if you hoped to use a USDA loan in a more populated suburb or city neighborhood. Make sure to verify the property’s eligibility before moving forward with the loan process.
3. Limited Occupancy Options
Borrowers must plan to use the USDA-financed home as their primary residence. That means USDA loans can’t be used for:
- Second homes or vacation properties
- Investment properties
- Rental properties
- Commercial real estate
You also can’t purchase a multi-unit property like a duplex or triplex unless you occupy one of the units. And you must move into the home within 60 days of closing.
These occupancy requirements are stricter than conventional loans, restricting how the property can be used. For real estate investors or those wanting a vacation home, USDA loans won’t work.
4. Upfront and Annual Fees
USDA loans require borrowers to pay two types of fees:
Upfront guarantee fee – This fee is 1% of the loan amount and can be financed into the mortgage. On a $200,000 loan, you would pay a $2,000 upfront fee.
Annual fee – Ongoing annual fees equal 0.35% of the original loan amount. On that same $200,000 loan, you’d pay $700 per year or $58 per month.
While still often lower than private mortgage insurance, these fees add to the cost and must be factored into your housing budget. They cannot be waived or removed.
5. Slower Loan Processing
It typically takes longer to close a USDA loan compared to conventional mortgages. Lenders have to verify you meet income limits, property requirements, and other program criteria.
This extended underwriting and approval timeline could be a disadvantage if you’re in a rush. USDA loans may not be the best fit if you need to close quickly for some reason.
6. Manual Underwriting Requirements
Most USDA loans require a manual underwriting process. This means an actual person will review your full financial profile rather than just inputting information into an automated underwriting system.
Manual underwriting takes more time and documentation. Be prepared to provide multiple records like pay stubs, tax returns, and bank statements when applying.
7. Potential Appraisal Delays
Only specially trained appraisers can perform appraisals for USDA home loans. In some rural areas, there may be a shortage of eligible appraisers.
Unlike conventional loans, you can’t just choose any local appraiser. This could lead to delays getting the mandatory appraisal scheduled and completed.
8. Difficulty Removing PMI Later On
USDA loans don’t require private mortgage insurance due to their government backing. But if you make a small down payment on a conventional loan, you typically have to pay PMI until reaching 20% equity.
With conventional loans, you can request PMI removal once hitting that 20% threshold. However, USDA loans make it harder to cancel the annual guarantee fee, even after building substantial equity.
This means you could be stuck paying the fee for the entire loan term, unlike with PMI. Not being able to remove the fee can really add up over time.
Should You Still Consider a USDA Loan?
While this list makes USDA loans seem full of drawbacks, for many borrowers the benefits still outweigh the negatives.
If you need flexible credit and a no down payment option for a modestly priced home in a qualified rural locale, USDA financing can be a great solution.
Just make sure you fully understand both the pros and cons before committing. Talk to loan officers about your specific situation. See if you can get pre-approved to verify the property and your finances meet all USDA eligibility requirements.
While not ideal for everyone, USDA loans provide a viable path to homeownership for millions of buyers. Don’t let the disadvantages deter you from at least exploring whether the program could work for your home buying needs.
USDA Loan Alternatives to Consider
If the limitations and downsides of USDA loans don’t work for you, here are some alternative programs to consider:
Conventional 97 – Allows 3% down payment on loans up to $650,000. No geographic restrictions.
FHA loan – Minimum 3.5% down payment. Available everywhere. Lower credit scores accepted.
VA loans – No down payment option for qualifying Veterans. Can be used anywhere.
Down payment assistance programs – State and local programs provide grants or low interest second loans to assist with the down payment. Amounts and eligibility vary.
Affordable housing programs – First-time homebuyer programs through non-profits and housing agencies provide below-market rate financing. Restrictions apply.
Seller financing – Seller provides financing directly to the buyer. Can be more flexible than bank financing in some cases.
Shared equity – Programs like community land trusts allow you to purchase a share of the home and share equity growth with a sponsor organization.
Don’t limit yourself to just USDA loans. Seek out professional advice to weigh all your options and find the best mortgage solution. Homeownership may be more attainable than you think, even without a USDA loan.
USDA Loan Limit = UNLIMITED
Most loans only allow borrowers to get a mortgage up to a certain point. For example, the VA mortgage and the conventional mortgage typically will not provide a loan higher than $548,250. FHA may loan a bit more, up to $625,000, but it must be in a high-cost area such as Los Angeles, Chicago, New York City, etc. Otherwise, the limit is much lower.
For a USDA loan, there is no expressly written limit provided in the guidelines. Loan amount limits are based on falling within the income limits and debt ratios of the USDA Rural Housing program.
USDA Borrowing Limit – AS MUCH AS THE HOUSE IS WORTH
The VA mortgage is one of the last remaining programs that will allow borrowers to buy a home without making a down payment. The FHA program requires a 3.5% down payment* and a conventional loan can range from 3% all the way to 20%. Jumbo loan requirements have changed in recent years and some lenders will allow only a 10% to 15% down payment, but that is not always the case. Many buyers seeking a jumbo home loan must often pay 20% to 30% as a down payment.
The USDA program will allow borrowers to receive a loan up to the home’s appraised value.
5 Things You Need to Know About USDA loans
FAQ
What is the disadvantage of USDA loans?
Are USDA loans worth it?
Why would an USDA loan get denied?
Can you pay off an USDA direct loan early?
Why does not everyone do a USDA loan?
The USDA loan includes a lot of really great features than can help you get into a home with almost nothing out of pocket. So why doesn’t everyone do a USDA loan? Just as the VA loan is only for veterans, the USDA loan has a strict qualifier as well: rural single family homes only, for low- to moderate-income homebuyers.
Can I get a USDA loan with bad credit?
Most lenders like to see a score of at least 640, but you may still qualify for a USDA loan with bad credit, depending on the lender and other factors. Your DTI measures the amount of your gross income that goes towards paying your debts every month.
What are the drawbacks of a USDA loan?
Perhaps the biggest drawback of the USDA loan is that many homes, because of their location, simply will not qualify, though a surprising number still will. Be sure to check the USDA website to determine if your location would qualify for a USDA loan. 2. More Red Tape and Waiting
Is a USDA loan right for You?
Depending on the borrower’s needs, a USDA loan may not be the right fit Paddio makes homebuying delightfully smooth. Friendly expertise. No pressure. Over $500 million funded. USDA loans are a useful way of making homeownership possible in rural areas when you don’t have money saved for a down payment. That’s right; you can own a home for $0 down.