Building a home can be a complicated process especially when it comes to financing it. A USDA construction loan is designed to simplify this process by bringing everything together under one loan. This zero-down, low-interest loan is a great option for low-to-moderate-income buyers looking to build a home in a rural area.
Buying your first home is an exciting milestone in life. But for many, the down payment and closing costs make homeownership seem out of reach. If you want to build a custom home in a rural area, a USDA construction loan could help make your dream a reality.
In this comprehensive guide we’ll explain what a USDA construction loan is who qualifies, and how the process works from start to finish. Whether you’re buying land to build on or constructing a home on property you already own, USDA financing offers unique benefits for eligible borrowers.
What is a USDA Construction Loan?
A USDA construction loan lets you buy land and build a new home with one mortgage loan It combines
- Financing to purchase land
- A construction loan to pay building costs
- A permanent 30-year fixed mortgage
With a conventional construction loan, you’d need separate loans for the land and construction. And once the home is built, you’d have to qualify and close on permanent financing.
The USDA construction loan streamlines this by rolling everything into one loan with a single closing. You only pay closing costs once. And there’s no need to requalify for a mortgage after the home is complete.
These loans are issued by traditional lenders and backed by the U.S. Department of Agriculture Rural Development program. The government guarantee allows for easier qualification and 100% financing.
USDA Construction Loan Requirements
USDA construction loans have eligibility requirements for you as the borrower, the property, and the builder. Let’s look at the key criteria:
Borrower Requirements
To qualify for a USDA construction loan, you’ll need:
- A minimum 640 credit score
- A debt-to-income ratio under 41%
- Income within USDA limits for your county and family size
- At least 2 years of clean credit with no late payments
- No bankruptcy in the past 1-3 years
Your lender will verify your income, assets, and employment. And they’ll want to see you have cash reserves after closing.
Property Requirements
The home you build must be located in a USDA-designated rural area. And it must be your primary residence, not a second home or investment property.
Eligible property types include:
- Single-family homes
- Certain condominiums
- Manufactured homes
The land value cannot exceed 30% of the total appraised value after construction.
Builder Requirements
Your builder must be USDA-approved. This means they must have:
- 2+ years of experience
- Proper licensing
- Liability insurance
- A clean background check
- Good credit
Using an eligible builder is key to getting approved.
How Does a USDA Construction Loan Work?
USDA construction loans simplify the home building process with a one-time close mortgage. Here are the basic steps:
1. Get pre-qualified – Work with a USDA lender to get a pre-qualification letter showing you meet the income and credit requirements. This helps when making an offer on land.
2. Find land to purchase – The property must be in an eligible rural location and zoned for residential use. Make an offer contingent on securing financing.
3. Select a USDA-approved builder – Partner with an experienced local builder who meets USDA criteria. Get a construction contract detailing the scope of work and costs.
4. Submit your USDA loan application – Provide all required documents to your lender, including land appraisal, construction contract, permits, and plans.
5. Close on your financing – At closing, your lender will disburse the land purchase funds. The rest of the loan will pay out incrementally based on construction progress.
6. Start building your home – After closing, it’s time to break ground! Work closely with your lender and appraiser during each stage of construction.
7. Move into your finished home – Once construction is complete, your USDA construction loan converts to a permanent mortgage.
The single closing simplifies the process. You lock in your long-term rate upfront without having to requalify later.
What Expenses Does a USDA Construction Loan Cover?
USDA construction loans provide 100% financing for all eligible costs associated with buying land and building a home. Covered expenses include:
- Land purchase
- Construction materials and labor
- Site preparation
- Design plans
- Permits and fees
- Builder’s risk insurance
- Interim interest
- Contingency reserve
- Initial escrow deposits
You can finance up to 100% of the as-completed appraised value. Any remaining loan funds after construction must be applied to the mortgage principal.
The Pros and Cons of USDA Construction Loans
USDA construction loans offer unique benefits. But they aren’t the right solution for everyone. Let’s look at the key pros and cons:
Pros
- One loan for land, construction, and permanent mortgage
- Single closing saves on costs
- No down payment required
- Below-market interest rates
- Available to borrowers with lower credit scores
- Fixed low monthly payments
Cons
- Limited to designated rural areas
- Home must be your primary residence
- Can only use USDA-approved builders
- Potentially fewer lenders offering this loan
- Higher upfront guarantee and annual fees
- Rates may be higher than alternatives
- Strict credit and income requirements
As you can see, USDA construction loans offer simplified financing for eligible borrowers. But make sure to shop around and compare all your options.
USDA Construction Loan Interest Rates
USDA construction loans come with below-market interest rates, making homeownership more affordable. Here are some current sample rates:
| Loan Term | Interest Rate |
|---|---|
| 30-year fixed | 5.25% |
| 25-year fixed | 4.75% |
| 20-year fixed | 4.50% |
| 15-year fixed | 4.00% |
Actual rates you’ll qualify for depend on your credit score, debt-to-income ratio, and other factors. USDA rates are typically 0.5 to 1% lower than conventional loans.
And they’re fixed for the full term, so your monthly payments will never change.
How to Apply for a USDA Construction Loan
Follow these steps when applying for a USDA construction loan:
1. Get prequalified – Work with a USDA lender to assess your eligibility and get a pre-approval letter.
2. Find land and a builder – The property and builder must meet USDA requirements for location and experience.
3. Submit loan application – Provide income and asset documentation, construction contract, permits, and property appraisal.
4. Close on your financing – Attend the closing to sign loan documents. Initial funds will be disbursed.
5. Start construction – Your lender will schedule releases of funds based on construction progress.
6. Move in – Once building is complete, the loan converts to a permanent mortgage.
The process takes about 6-12 months from start to finish. Work closely with your lender throughout each stage of the construction loan.
7 Tips for Getting Approved
Here are some tips to boost your chances of getting approved for a USDA construction loan:
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Shop around – Compare multiple lenders as not all offer USDA construction loans.
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Get prequalified – This shows sellers and builders you can get financing.
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Know your budget – Have a budget for land, construction, fees, and closing costs.
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Check your credit – Give yourself time to correct any errors and pay down balances.
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Document income – Have 2 years of stable income history with your current employer.
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Save for closing – Have reserves to cover your down payment and closing costs.
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Hire a USDA-approved builder – An experienced local builder is key to approval.
Meeting all the requirements upfront will make for a smooth loan process.
Alternatives to USDA Construction Loans
If you don’t qualify for a USDA loan, here are some alternative construction loans to consider:
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FHA construction loan – Requires 3.5% down payment and has looser credit requirements than conventional loans.
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VA construction loan – For veterans and service members. No down payment but has a funding fee.
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Conventional construction loan – Typically requires 10-20% down payment. Get personalized rates from lenders like Rocket Mortgage.
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Renovation loan – Finance home improvements and renovations through FHA 203(k) and homestyle renovation loans.
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Owner-builder construction – If you have construction experience, you can get an owner-builder loan and act as your own contractor.
USDA Construction Loan Requirements
Requirements for USDA construction loans are similar to those for other USDA loan types. Your total household income cannot exceed the USDA income limits for your local area. These generally start at $110,650 for a household of up to four, but they may be higher based on an areas cost of living.
Although the USDA doesnt have its own minimum credit score requirement, some lenders look for a score of at least 640. Other lenders, like Neighbors Bank, can go as low as 620, so it may help to shop around if your credit history is an issue. Youll also typically need a debt-to-income ratio at or below 41%. The amount you spend on housing, including property taxes, insurance and homeowners association fees, cant be more than 29% of your income.
What Are USDA Construction Loans?
USDA construction-to-permanent loans, or USDA construction loans for short, are a type of one-time close mortgage guaranteed by the U.S. Department of Agriculture (USDA). These loans are part of the USDAs Single Family Housing Guaranteed Loan program, which aims to make homeownership more accessible for rural, low- or moderate-income homebuyers.
Although the majority of loans issued under the program are for existing single-family home purchases, the USDA construction loan is unique because it allows the buyer to finance the purchase of land and the cost of constructing a new home on it. Unlike many other construction loans, which require one loan for construction and another for buying the land, everything in a USDA construction loan is under one umbrella with one closing.
Because theyre guaranteed by the USDA, these loans offer generous terms — often including no down payment requirement. That makes them a great option for some rural home buyers. The downside is that there are very few USDA construction loan lenders on the market right now.
USDA Construction Loan Requirements 2024 Full Guide!
What are the advantages and disadvantages of a USDA construction loan?
As with all mortgage types, there are both advantages and disadvantages to using a USDA construction loan. Here are some of the benefits of using a USDA construction loan: This loan gives you the opportunity to build a home and finance that home’s purchase in one loan with one closing date.
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.
Can a USDA construction loan finance a home?
Building a home can be expensive. And taking out both a construction loan and primary mortgage to finance this can be challenging. Fortunately, a USDA construction loan can help with both problems. These loans require no down payment, and you’ll only need to close one loan to finance both the construction of your residence and the home itself.
How do I get a USDA construction loan?
You can apply for a USDA construction loan with USDA-approved lenders who offer this loan program. Search online for available lenders. A USDA construction loan can be an attractive and affordable option for buying land and building a home. But these hard-to-find loans aren’t available to everyone.