Buying land and building a custom home is an exciting prospect for many prospective homeowners Being able to design and construct your ideal residence from the ground up can help you create the perfect living space tailored to your family’s needs. However, financing such an endeavor can seem daunting. That’s where USDA loans can help
USDA loans are backed by the U.S Department of Agriculture and aim to help moderate-income families in rural areas achieve homeownership One type of USDA loan that may work well for constructing a new house is the USDA Single Family Housing Guaranteed Loan, also known as a USDA construction loan or USDA combo loan.
This loan combines three key elements into one mortgage:
- Land purchase
- Construction financing
- Permanent fixed-rate financing
In this article, we’ll break down everything you need to know about using a USDA construction loan to build your dream home. We’ll cover:
- USDA Loan Overview
- Requirements and Eligibility
- Pros and Cons
- Interest Rates and Fees
- How to Apply
- Tips for Success
Let’s get started!
Overview of USDA Construction Loans
USDA construction loans allow you to buy land, build a home on it, and lock in long-term fixed mortgage rates all with one loan. Rather than getting separate mortgages for the land and construction, this loan bundles everything together.
The USDA guarantees these mortgages, making lending less risky for banks. In return for this guarantee, home buyers get very favorable loan terms.
USDA construction loans offer:
- 100% financing – No downpayment required
- Below-market interest rates – Thanks to the USDA guarantee
- One closing – Lower closing costs than with multiple loans
You work with USDA-approved lenders, builders, and real estate agents to make the process as streamlined as possible.
USDA Construction Loan Requirements
USDA loans have eligibility requirements related to your finances, credit, the property location, and more. Key criteria include:
- Credit score – Usually 640 minimum
- Debt-to-income ratio – Typically 41% or less
- Income limits – Varies by location, household size
- Home location – Must be in an eligible rural area
- Property type – Single-family home, condo, or manufactured home
You’ll also need to use a USDA-approved builder and get a home warranty. The home must be your full-time residence, not a vacation or rental property.
Meeting all the requirements takes some work but it widens homeownership access for rural families.
Pros and Cons of USDA Construction Loans
USDA construction loans offer home builders several advantages:
Pros
- One loan for land, construction, and the mortgage
- Single closing keeps costs down
- No downpayment required
- Below-market interest rates
- Can use USDA Streamline Refinance after 6 on-time payments
Cons
- Hard to find lenders that offer this loan
- Strict eligibility requirements
- Lengthy application and approval process
- Higher rates than conventional loans
- Upfront and annual guarantee fees
The biggest tradeoff is extra paperwork for simplified financing and 100% financing. Make sure you understand all the ins and outs before applying.
Interest Rates and Fees
USDA construction loan rates are usually higher than rates on conventional mortgages due to the government guarantee. The USDA charges an upfront guarantee fee of 1% of the loan amount and an annual fee of 0.35% of the original loan amount.
However, the no downpayment feature helps keep monthly payments affordable despite the higher rate. And you may be able to refinance later on to snag a lower rate after making 6-12 on-time payments.
How to Apply for a USDA Construction Loan
Getting approved for a USDA construction loan takes some extra legwork but can really pay off. Here are the main steps:
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Find a USDA-approved lender – Many banks don’t offer this product, so search thoroughly.
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Select a USDA-approved builder – They must have 2+ years of experience plus good credit and insurance.
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Choose a qualifying property – It must be in a USDA-designated rural area and zoned for single-family use.
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Submit your application – Provide all required financial, employment, and identification documents.
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Get an appraisal + inspection – The lender needs to verify the property value and condition.
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Close on the land + construction financing – Now the building can begin!
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Make payments during construction – You pay loan fees and interest charges during the build.
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Complete construction – Once the home is finished, the loan converts to a traditional fixed-rate mortgage.
The entire process takes several months so be prepared for a wait. But the payoff is your ideal home!
Tips for Success With a USDA Construction Loan
If you think a USDA construction loan is right for you, keep these tips in mind:
- Find a knowledgeable loan officer familiar with USDA programs
- Ask builders if they’re worked with USDA loans before
- See if sellers may be willing to finance the land purchase separately
- Shop around for the best rates and lowest fees
- Get cost estimates in writing before committing
- Be ready for a lengthy process with lots of paperwork
- Save extra money to cover any unexpected overages
Wrap Up
Building a custom home is a major financial undertaking but USDA construction loans make it possible even if you don’t have 20% to put down. This unique loan bundles together land financing, construction costs, and your permanent mortgage into one. This simplifies the process but be ready for strict eligibility standards.
Submit your loan application
After you’ve gathered all the necessary information, you’re ready to send off your USDA loan application.
Before submitting your application, confirm your contractor and the location of your property, as these details are required for qualification. Depending on your specific circumstances, the loan process can take up to 60 days to complete.
FHA one-time close construction loan
The Federal Housing Administration (FHA) backs the FHA one-time close construction loan. It’s an option that particularly appeals to first-time home buyers.
With the possibility of putting down as little as 3.5%, it offers an accessible route to homeownership for those who might not have a significant amount of savings. Additionally, FHA loans are known for their lenient credit guidelines, making them more accessible to a broader range of buyers, including those with less-than-perfect credit scores.
USDA Construction Loan Explained by a USDA underwriter
FAQ
What is the maximum debt to income ratio for USDA?
What is the interest rate for the USDA construction loan in 2024?
Can you buy a home with a USDA construction loan?
A USDA construction loan allows you to purchase both the land and the home. But some restrictions apply. For example, the land must be in a USDA-approved location. These areas must be “rural in character,” though many small towns and suburbs qualify. “Also, this is not a loan that you can use to purchase land now and build on it at a later time.
What is a USDA construction loan?
USDA construction loans can finance the land, build your home, and serve as your long-term mortgage. They essentially roll three loans into one. Plus, there’s no down payment required and only one set of closing costs. However, these loans can be hard to find. You also need to be eligible and build in a qualified rural area.
Should you consider a USDA Rural Development Loan?
Consider a USDA rural development loan if you’re interested in buying, refinancing or renovating a home in a rural community that will be your primary residence. The first step is talking to a USDA-approved lender, who can help you explore all the loan options available to find the right mortgage for you.
What financing options does USDA Rural Development offer?
USDA Rural Development and its lending partners have affordable financing options for homebuyers who are considering building their dream home. Through USDA Rural Development’s Combination Construction-to-Permanent Loan Program (PDF, 158 KB), USDA-approved lenders with experience in construction loans can help borrowers who want to build a home.