In today’s high-priced, unpredictable housing market, selecting the right mortgage is a make-or-break moment. Choose right, and you could save many thousands of dollars on interest, closing costs, and more.
While many mortgage options are available, one type that’s often overlooked is a USDA loan from the United States Department of Agriculture—and it comes with a range of advantages.
“The benefits of a USDA loan are huge—no down payment required, frequently better interest rates than comparable conventional or government loans, reduced mortgage insurance called the USDA Guarantee Fee, and [acceptable] credit scores as low as 640,” says Tan Tunador, a senior loan officer with Atlantic Coast Mortgage in Loudon County, VA.
Despite all these money-saving perks, USDA loans are frequently passed over because they’re plagued by some persistent myths. To help clear up the confusion, here are some of the most rampant misconceptions about USDA loans, along with some reality checks.
Whether you or someone you know is getting a loan, make sure these fictions aren’t impeding major savings.
Myth No. 1: You have to live way out in the country to get a USDA loan
Because these loans come from the U.S. Department of Agriculture, many people mistakenly think you must buy a farm or at least live way out in the country to qualify.
“Many home shoppers and real estate professionals assume that USDA loans are only for farms and rural properties, but in fact they can be used for most property types, including condominiums, townhomes, and modular or manufactured homes,” says Tunador. “The key is that the property location must be in an area deemed ‘rural’ by the USDA and is qualified based on census tract data.”
According to the Housing Assistance Council, 97% of American land is within USDA loan–eligible boundaries. Plus, many areas that aren’t so far from small- and mid-sized cities might be classified as rural areas by the USDA.
What’s more, homes in the suburbs could be included, according to Sue Barber, national sales manager for Wells Fargo Home Lending. In the Atlanta area, for example, some or all of the homes in suburbs such as Braselton or Senoia would be eligible for USDA financing, Barber says. Likewise, homes in Erie or Evergreen in the Denver suburbs; or properties in Prosper, Argyle, and Roanoke in the Dallas-Fort Worth area also could be eligible.
“My team works in a suburban area just 35 miles west of Washington, D.C., and frequently, home shoppers are surprised when I show them developed areas which qualify for USDA financing,” says Tunador.
To find out if a certain location qualifies for a USDA loan, home shoppers can use the interactive map on the agency’s website. Eligible homes are also denoted on Realtor.com listings.
Myth No. 2: USDA loans are only for first-time homebuyers
Another misconception is that USDA loans are only for first-time homebuyers.
“People tend to believe this, because USDA loans cannot be used for investment properties,” says Jill Gonzalez, an analyst for WalletHub.
To qualify for a USDA loan, a home cannot be a vacation home or designed for income-producing activities. Qualifying individuals must use a USDA loan for their main residence and live in it.
“The house you purchase with your USDA loan does not need to be your first, but it has to be your primary residence,” says Gonzalez.
Basically, if you’re just looking to move from one house to another, this is definitely an option to explore.
Myth No. 3: You need a down payment to qualify for a USDA loan
Actually, one key reason to apply for a USDA loan is because, very often, no down payment is necessary.
“For qualified, low-income applicants, USDA offers up to 100% financing; and closing costs and prepaid charges can also be financed into the loan,” says Barber. “As a result, buyers with limited assets can still qualify and, in fact, many USDA loan customers don’t have to bring money to closing, if the appraisal supports the loan amount required.”
In some cases, where closing costs and prepaid charges (such as an earnest money deposit, also known as an escrow deposit) can be financed, Barber says eligible costs paid upfront by the customer can even be refunded then rolled into the life of the loan.
Myth No. 4: The insurance costs for a USDA loan are higher than regular loans
Usually when someone makes a down payment of less than 20% on a home, they are also required to carry private mortgage insurance (PMI), which guarantees the loan. Because people who qualify for a USDA loan often don’t need a down payment, another common myth about USDA loans is that the mortgage insurance costs are high.
“Other low down payment loans may have high insurance costs, but this is not the case with USDA loans,” says Gonzalez.
The reality is that people with USDA loans don’t need to provide PMI, because there is a “guarantee fee” that is specific to USDA loans. This acts as the mortgage insurance and is typically 1% of the loan amount upfront and then an annual fee of 0.35% of the loan amount.
“Not only are these costs low, but you also have the possibility to include these fees and other closing costs in your mortgage loan, which is an added benefit,” says Gonzalez.
Myth No. 5: There are no negotiations of the terms with a USDA loan
There are two main types of USDA loans: USDA direct loans, which are available only for low-income applicants and come directly from the USDA, do not have negotiable terms. However, that is not the case with USDA guaranteed loans, which are offered through approved lenders who work with the USDA.
“The interest rate for the guaranteed loan program is negotiated between lender and borrower and depends on factors such as credit score, financial situation, and employment history,” says Gonzalez.
In other words, there is some wiggle room when it comes to shopping for USDA guaranteed loans with different USDA-approved lenders.
“A borrower can be excited about the USDA opportunity, approach a private lender to do the USDA [loan], and be told he is not qualified due to his credit being 620, whereas another lender might add down payment requirements because of the credit score; and a third [lender] might offer something completely different,” says real estate agent and mortgage loan officer Orli Dudaie, author of “Your Home, Your Money.”
Dudaie also says that while the interest rate might be variable with different lenders, one thing that isn’t up for negotiation is that it must be a fixed-rate mortgage. But that’s a good thing, since it will typically be lower than standard industry mortgage rates.
“The bottom line is that, like with other types of loans, homebuyers should shop around before settling on a lender, to make sure they get the best offer,” says Gonzalez.
Myth No. 6: You must have a good credit score to secure a USDA loan
Another misconception about USDA loans is that they are only for those with good credit.
“The truth is, you can qualify for a USDA loan with less than perfect credit, as long as you’re able to prove you can afford your mortgage payments,” says Gonzalez.
Lenders are more willing to accept a slightly lower credit score, owing to the USDA guarantee fee mentioned above. That way, if the homebuyer defaults on the loan, there is insurance in place so the lender doesn’t lose the funds they’ve put up for the sale.
While a good credit score is always better to have (especially if you’re working through a lender rather than getting a direct loan from the USDA), don’t let a less-than-perfect credit score keep you from trying this route.
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