Demystifying the Key Differences Between USDA Guaranteed and Direct Loans

Buying a home in a rural area comes with its own unique set of challenges. With fewer housing options and financing products tailored to rural locations it can be tough for buyers to secure affordable home financing. That’s where USDA home loans come in. These specialized mortgage options from the United States Department of Agriculture (USDA) make owning a home in rural locales more feasible.

When researching USDA loans, you’ll quickly notice two main options USDA guaranteed loans and USDA direct loans. Both offer perks like low interest rates and lenient credit requirements. However guaranteed and direct loans work differently and have distinct eligibility rules.

In this comprehensive guide, we’ll demystify the key differences between guaranteed and direct USDA home loans. You’ll walk away with clarity on how these loans work, their specific pros and cons, and how to decide which is best for your home buying needs.

A Quick Intro to USDA Guaranteed and Direct Loans

Let’s start with a quick overview of both loan types

USDA Guaranteed Loans

With a USDA guaranteed loan, the USDA guarantees the mortgage, protecting the lender against loss if the borrower defaults. However, the loan is made by private lenders like banks and credit unions. Guaranteed loans are more widely available since private lenders offer them.

Borrowers can earn up to 115% of the median income for the area to qualify. The USDA backs the loan, enabling lenders to offer better rates.

USDA Direct Loans

USDA direct loans are financed directly by the USDA rather than private lenders. They are less common but provide a financing option for low-income buyers.

Borrowers must earn less than 80% of the median income where they buy to qualify. The USDA serves as the lender and provides the loan funds. Rates may be below market averages.

Now that you have the basics down, let’s explore the key differences in more detail.

Comparing Loan Eligibility and Terms

When deciding between guaranteed and direct USDA loans, pay close attention to the eligibility and loan terms. These areas have some of the biggest differences.

Income Limits

One major contrast is the income limits attached to each loan:

• Guaranteed loans have an income cap of 115% of the median income for the area. For a family of 4, this equals $97,010 nationally.
• Direct loans are for lower earners with incomes at 50-80% of the local median. This equals $48,700 to $77,920 for a 4-person household.

Clearly, direct USDA loans cater to buyers on tighter budgets. But guaranteed loans still help moderate income buyers access home financing.

Loan Terms

You’ll also encounter different loan terms with each USDA product:

• Guaranteed loans come with 30-year terms and fixed interest rates set by lenders.
• Direct loans offer unique 33 and 38-year terms with below market fixed rates set by the USDA.

The extended repayment period helps lower income buyers afford the monthly payments on direct USDA loans. But guaranteed loans offer predictable 30-year terms.

Credit Requirements

When it comes to credit, the USDA does not impose rigid minimum scores for either direct or guaranteed loans. However, lenders often require at least a 640 FICO for guaranteed loans. The USDA reviews each applicant individually. If you have a past bankruptcy or foreclosure, you may still qualify.

Direct loans specifically cater to borrowers with imperfect credit. These loans emphasize repayment ability over your credit profile. If your income meets the limits, poor credit is unlikely to hold you back from a direct USDA mortgage.

Available Properties

Both direct and guaranteed USDA mortgages can finance homes, townhouses, condos and even manufactured homes. However, direct USDA loans add the restriction that homes must be 2,000 square feet or smaller. So you can only use a direct loan to buy a modest sized property.

No matter the loan type, the home must be located in an eligible rural area. You can check addresses using the USDA’s property eligibility tool.

Unique Benefits of Each USDA Loan

Guaranteed and direct USDA loans overlap in offering the core benefits of USDA financing. But each option also brings unique advantages.

Perks of Guaranteed Loans

Guaranteed USDA loans offer home buyers advantages including:

• Easier to obtain: Since they are offered by private lenders, guaranteed loans provide the most access to USDA financing.
• Higher incomes: The 115% income cap enables more moderate income buyers to utilize guaranteed USDA loans.
• No size limits: You can use a guaranteed loan to buy homes of any square footage.
• Lower UPFRONT costs: Lenders can roll closing costs into the loan balance so buyers avoid large upfront fees.

By opening USDA financing up to more buyers, guaranteed loans expand access to homeownership. Their wide availability through private lenders also makes them simpler to obtain compared to limited direct loans.

Advantages of Direct Loans

Direct USDA home loans also come with unique perks:

• Very low income limit: Direct USDA loans cater to extremely low income buyers shut out of other programs.
• Lower rates: As a government loan, direct USDA loans offer interest rates below conventional options.
• Added rehab money: You can roll repair and renovation costs into direct USDA loans.
• Longer terms: The 33 and 38-year repayment terms make direct loans more affordable.

For home buyers with limited means, direct USDA loans offer an affordable path to ownership. From low rates to generous terms, these loans provide options tailored specifically to lower income borrowers.

Drawbacks to Weigh with Each Loan

While their benefits are ample, direct and guaranteed USDA loans aren’t without a few drawbacks. Keep these cons in mind too:

Potential Downsides of Guaranteed Loans

When considering a guaranteed USDA loan, be aware that:

• Strict rural location: Properties can only be in very rural designated areas, limiting selection.
• Tough to refinance: Refinancing or switching lenders requires adhering to tight USDA rules.
• Added fees: You’ll pay an upfront guarantee fee of 1% and annual fee of 0.35% with guaranteed loans.

Location limits, tough refinancing, and fees make guaranteed loans less flexible than conventional mortgages. But for buyers set on rural living, the tradeoffs are often worthwhile.

Limitations of Direct Loans

Direct USDA home loans also have disadvantages such as:

• Harder to find: Since only USDA offices offer direct loans, they can be trickier to locate and apply for.
• Smaller loan sizes: Given their low income limits, maximum loan amounts are lower compared to guaranteed loans.
• Strict credit: While flexible, the USDA still evaluates if you can reasonably afford payments based on your credit profile. Poor credit can jeopardize eligibility.

The limited supply and tighter loan sizes of direct USDA mortgages narrow their appeal. And you still need to demonstrate a willingness to repay based on your credit history.

How to Apply for Each USDA Loan

Ready to move forward with a guaranteed or direct USDA home loan? Here are the steps to take when applying for each option:

Getting a Guaranteed USDA Loan

Since guaranteed USDA mortgages are made by private lenders, begin by contacting participating banks or credit unions. You can apply and submit documents directly to the lender you choose to work with.

The lender handles the approval process and loan underwriting. All you need to do is select your lender, complete their application and submit required documents to get the ball rolling!

Applying for a Direct USDA Loan

Unfortunately, direct USDA loans cannot be applied for online. To request a direct loan, you must locate a local USDA Rural Development office and apply in person.

The USDA office can guide you through the application process and specify what documents and information you need. They will also determine if your income and credit qualify before approving the loan.

Because direct loans are less readily available, extra effort is required to find and apply through your area’s Rural Development office. But the hardship may pay off if you need the benefits of the direct loan program.

Which USDA Loan is Right for You?

As you weigh guaranteed versus direct USDA loans, consider which fits your unique situation:

• Guaranteed loans are best if you want wider availability, higher incomes, or larger homes.
• Direct loans are ideal if you need down payment help, very low rates, or have poor credit.

Thinking through your location needs, income, desired home size, and credit can steer you towards the most fitting USDA loan choice. For wide qualification, flexible terms, and easier access however, USDA guaranteed loans are the best bet for the majority of borrowers.

Let a USDA Specialist Help You Choose

Comparing guaranteed against direct loans equips you to zero in on the right