The Pros and Cons of USDA Home Loans: Everything You Need To Know

USDA home loans have become an increasingly popular mortgage option for many homebuyers in recent years As one of the few no-down-payment loan programs available, USDA loans provide a path to homeownership for buyers who may not qualify for conventional mortgages. However, like any mortgage product, USDA loans also come with some potential drawbacks In this comprehensive guide, we’ll walk through the key pros and cons of USDA loans to help you determine if this type of financing is right for you.

What is a USDA Home Loan?

Before diving into the pros and cons, let’s start with a quick overview of what exactly USDA loans are. USDA stands for the United States Department of Agriculture. The USDA runs a mortgage loan program designed to promote homeownership in rural areas.

USDA loans offer 100% financing, meaning you can qualify for the mortgage without any down payment. The loans are backed by the federal government, so lenders face less risk which allows them to offer more flexible underwriting standards.

In order to qualify for a USDA loan, the home you wish to purchase must be located in an eligible rural area as defined by the USDA property eligibility map. Your household income must also fall under the income limits set for each county. The income thresholds range from moderate to low, allowing low-to-moderate income buyers to qualify.

Now that you understand the basics of USDA loans, let’s take a closer look at the key advantages and potential disadvantages.

The Pros of USDA Loans

1. No Down Payment Required

The biggest benefit of USDA loans is the ability to buy a home with no money down. As one of the few zero down payment mortgage options, USDA loans provide a path to homeownership for buyers who haven’t had time to accumulate savings for a down payment.

With a conventional loan, you typically need at least 3-20% down to avoid private mortgage insurance (PMI). But with a USDA loan, you can qualify for 100% financing. This makes these loans ideal for first-time homebuyers or anyone without substantial cash reserves.

2. More Relaxed Credit Standards

Since the loans are backed by the government, USDA underwriting guidelines are more flexible than conventional loans. Many lenders require a minimum credit score of 640 for USDA approval. But some may approve scores as low as 580 or 600. This gives borrowers with less-than-perfect credit access to home financing.

USDA loans can be a great option if you have medium-to-low income but are working to rebuild your credit. The loans offer credit-challenged buyers a chance at homeownership that may not be possible with stricter conventional loans.

3. No Required Cash Reserves

Most conventional and government loans require you to have cash reserves equivalent to two or more mortgage payments after closing. But USDA loans do not have any cash reserve requirements. This makes it possible to buy a home even if you have limited funds left over each month after covering your housing payment.

4. Lower Mortgage Rates

Since the loans are backed by the government, lenders face less risk of default. This allows them to offer lower interest rates compared to some other loans with flexible credit standards. USDA mortgage rates are very competitive, often coming in close to rates for conventional loans.

The lower interest rate helps reduce your monthly payments and saves you money over the life of the loan. Lower rates provide relief to buyers trying to afford a home on a tight budget.

5. Loosen Income Limits

Income limits for USDA loans range from moderate to low depending on the area. This opens up homebuying opportunities to buyers with low-to-moderate household income in eligible regions.

For example, in my area the income limit for a family of four is $102,000 per year. In more expensive counties, the ceiling may reach as high as $146,050 for large families. The wide range gives more buyers a chance to qualify based on their income.

6. Low Upfront Fees

Closing costs with a USDA loans typically range from 2-5% of the loan amount. On a $250,000 home purchase, that would come out to $5,000-$12,500 at closing.

However, most lenders allow you to roll closing costs into the USDA loan balance. This prevents high upfront fees from derailing the homebuying process. Sellers may also agree to cover closing costs in some situations.

7. No Prepayment Penalties

USDA loans do not charge prepayment penalties if you pay off the mortgage early. This provides flexibility down the road if your financial situation changes. With some loan types, you can face fees for early repayment which makes it expensive to refinance or sell.

The Cons of USDA Loans

While USDA loans offer some excellent benefits, there are also a few potential drawbacks to consider before applying.

1. Strict Home Eligibility Rules

One of the biggest disadvantages of USDA loans is the strict property eligibility requirements. The home you wish to buy must be located in a rural area as defined by the USDA property eligibility map.

Urban and suburban areas usually do not qualify under the population and density restrictions. And eligible regions vary greatly by state. So be sure to double check the USDA eligibility map before you get too far down the road.

If the home you have your eye on is not in a qualifying rural location, a USDA loan will not be an option.

2. Limited to Primary Residences

USDA loans must be used to purchase a primary residence – not a second home or investment property. These restrictions limit the types of real estate you can finance with a USDA mortgage.

If you hoped to use the loan for a vacation home or rental property, unfortunately USDA guidelines do not allow it. The property must be where you live the majority of the year.

3. Potentially Longer Processing Time

Some borrowers report longer processing and underwriting times for USDA loans compared to conventional mortgages. Lenders have to take additional steps to verify program compliance and eligibility.

In some cases, buyers had to delay closing or faced difficulties aligning closing dates with the seller due to the extended USDA timeline. While longer waits are not guaranteed, it’s a possibility to be aware of.

4. Upfront and Annual Loan Fees

All USDA loans require an upfront guarantee fee of 1% of the loan amount. On a $200,000 loan, this equates to $2,000 due at closing. You can finance the fee in your loan, but either way it’s an extra cost.

There is also an annual guarantee fee of 0.35% of the loan balance. So on a $200,000 mortgage, you would pay $700 per year. The annual fee can be paid monthly along with your mortgage payments. But it still increases your long term costs.

5. Potential Difficulty Finding a Qualified Lender

Not all mortgage lenders write USDA loans. So you may have less choice and flexibility when it comes to choosing a lender. Large national lenders are less likely to deal with niche products like USDA mortgages.

Your best bet is to find a local lender familiar with USDA eligibility rules and application specifics. Working with an experienced loan officer can help streamline the process.

How To Determine If a USDA Loan Is Right For You

USDA loans offer a great opportunity for certain homebuyers, but also come with limitations and drawbacks. Here are a few key questions to ask yourself when deciding if a USDA mortgage makes sense for your situation:

• Is the home I want to buy located in a USDA eligible rural area? Check the USDA property eligibility map to be sure.

• Does my household income fall under the income caps for my county and family size? The income thresholds vary across counties so be sure to verify you qualify.

• Am I comfortable with the upfront and annual loan fees required for USDA financing? Make sure you factor these costs into your homebuying budget.

• Do I meet the minimum credit score requirements? Check with lenders to see if your credit score will allow approval.

• Am I able to find a lender in my area experienced with USDA loans? Search for local lenders familiar with the program specifics.

If the answers to these key questions are “yes”, a USDA loan may be a great fit to help you buy a home with little money down. But if you don’t meet the location or income requirements, another mortgage product may make more sense for your situation.

Carefully weigh the pros and cons and speak with a qualified loan officer. Make sure you understand all the eligibility rules and costs before applying. USDA loans provide a flexible financing option but also have limitations compared to conventional mortgages. Analyze your personal scenario to decide if the benefits outweigh the potential disadvantages.

The Bottom Line

USDA loans allow buyers to purchase a home with no down payment and offer more relaxed credit standards than many mortgage products. This provides a lifeline for low-to-moderate income buyers who may not qualify through traditional lending channels.

However, USDA loans come with strict property eligibility rules, upfront fees, and potential delays. You need to be sure you meet the requirements and are comfortable